Knowledge that Transforms

We report here a few results of oligopoly experiments which we carried out several years ago. These are laboratory experiments with human subjects along the lines of Lawrence Fouraker and Sidney Siegel (1963), Friedman (1967) and Hoggatt (1969). We sought to observe the predictive power of various theoretical equilibria. Then, to the extent that theoretical equilibria do not predict observed behavior, we seek to understand that behavior as best we can in the hope that the existing body of theoretical knowledge can be improved upon. We used a simple textbook model of an oligopoly, then arranged for undergraduate student subjects to be the in the market. Our markets have 2, 3, 4 or 6 firms, each represented by one subject. One single consists of a period of 1 X2 to 2 hours during which one group of subjects forms a market. For example, in a 3-firm market there would be 3 subjects each in a different room in the laboratory. Each would make the price and output decisions for his firm, and the pay to each for his participation in the game would consist only of the profits of his firm. At the beginning of the game, each would make the price and output decisions for his firm, and the pay to each for his participation in the game would consist only of the profits of his firm. At the beginning of the game, each subject would make his initial price and output decision. These initial decisions would remain in effect until changed by a subject; and he would be free to change either his price or output (or both) at any time. A particular game or market with its fixed set of firms (subjects) would remain in continuous operation for approximately an hour and a half. The time periods are approximately 40 seconds each; and every fourth period, the subject receives a report on his sales, production, inventory, profit, etc. These time periods are sufficiently short that they approximate continuous time for the subject, especially given that there is not time in the whole game, except the beginning, when the subject must actively choose a price and an output level. Anytime afterward he can change his price and/or output level by entering new ones. They take effect at the start of the time period following. Our experimental design was chosen with several objectives in mind: casual evidence, formal evidence (Friedman 1967), and intuition all suggest that sub* Professor of business administration, University of California, Berkeley, Professor of economics, University of Rochester, and Research Assistant, Center for Research in Management Science, University of California, Berkeley, respectively. We are grateful for research support to the National Science Foundation for GS-2423 and GS-2463, to the University of Rochester and to the University of California. The Center for Research in Management Science, Berkeley, where this research was carried out, operates a computer controlled laboratory for the study of human behavior. A manual describing the experimental control programs and the observations on which this paper is based is available on request.

The Coase Theorem states that under certain ideal conditions resource allocation is unaffected by liability rules. This result, however, applies only in the absence of transaction or negotiation costs. Moreover, even though resource allocation remains unaffected, the income distribution between the parties is largely influenced by the liability rule. Take the celebrated example of a confectioner and a dentist. The final level of production activity after negotiation between the parties remains the same regardless of which party is liable. But the distribution of income between the confectioner and the dentist depends crucially on which party has the right to the environment. One of the characteristics of product liability is that producers and consumers are directly or indirectly associated through the price relationship. This very fact gives rise to a case where the conclusion of the Coase Theorem holds true even in the absence of explicit negotiations between the parties. Moreover, under certain conditions, the income distribution in terms of consumers' and producers' surplus could remain the same regardless of the liability rule. The purpose of this paper is to explore the implication of this price relationship on the product liability. In Section I, I shall analyze the case of product liability where the probability of damage is independent of the level of care taken by producers and consumers. It will be shown in a partial equilibrium framework that not onlv resource allocation but also income distribution in terms of consumers' and producers' surplus is unaffected by the liability rule, provided that consumers are fully informed of the intensity and the probability of the danger. In Section II, the assumption of the independence of the probability of damage from the care level is dropped. It will be shown that the game theoretic result obtained by John Brown' is still valid even if the quantity to be produced and consumed is a variable.

Robert Clower has presented a hypothesis of household behavior under conditions of involuntary unemployment; in his analysis, Clower contends that a constraint in labor supply implies a decrease in demand for consumer goods. Robert Barro and Herschel Grossman (1971, 1974) generalized Clower's analysis to include the case where the quantity of consumer goods available is less than the demand at the going price, i.e., the case of excess demand. The Barro-Grossman disequilibrium model provides a framework for analyzing the effects of repressing inflation by means of price controls. The model predicts that such a policy will lead to increased saving and, more importantly, a reduction in labor supply. The latter response will have a multiplier effect on outptit. Given the potential importance of the implications of these effects, particularly the labor supply response, it would seem of utmost importance to test this model empirically. Such tests must have two objectives: to test the direction of response, i.e., the predictive ability of the theory; and to measure the size of the response. This paper is an attempt to accomplish these two objectives. The Soviet Union is chosen here as a case study. It is generally believed that there was repressed inflation in the Soviet economy during the period 1955-67,1 the years chosen for this study. Although conditions were getting better during this period, many of the controlled prices on the official retail markets were set below market-clearing levels; thus creating the possibility of the various spillover effects referred to by Barro and Grossman.2 A model similar to that of Barro and Grossman is applied here to the Soviet household sector. For the Soviet case one other market must be introduced, the uncontrolled or free consumer good market (for example, the collective farm market). Prices and availability of goods on the state and cooperative retail market are government policy parameters and these prices are usually set below marketclearing levels. Household saving mostly takes the form of increases in savings deposits (and cash hoards). The disequilibrium model predicts that if the amount of goods available on the state and cooperative retail market decreases (increases) then labor supply decreases (increases), demand on the collective farm market and other free markets increases (decreases), and saving increases (de* International Finance Division, Federal Reserve Board. Most of this research was done at the University of Virginia and was supported by the Thomas Jefferson Center Foundation of Charlottesville, Virginia. This paper represents my views solely and should not be interpreted as reflecting the views of the Board of Governors of the Federal Reserve System or other members of its staff. I would like to thank the managing editor and an anonymous referee for helpful comments on an earlier draft of this paper. For a brief discussion of the evidence for this belief, as well.as a partial listing of those holding it, see the author (1975, pp. 57-59). For another partial listing of those who hold the belief, as well as a dissenting view, see Richard Portes. 2 In fact, they refer to the applicability of their model to the situation in the U.S.S.R. See Barro and Grossman (1971, p. 91, fn. 18).