Knowledge that Transforms

Most markets clear through a sequence of sales rather than through a Walrasian auctioneer. Because buyers can decide whether to buy now or later, rather than only now or never, their current "willingness to pay" is much more sensitive to price than the demand curve is. A consequence is that markets will be extremely sensitive to new information, leading to both "frenzies," in which demand feeds on itself, and "crashes," in which price drops discontinuously. The paper also shows how a result from static auction theory, the revenue equivalence theorem, can be applied to solve for a dynamic price path.

With asymmetric information, full commitment to long-term contracts may permit markets to approach first-best allocations. However, commitment can be undermined by opportunistic behavior, notably renegotiation. The authors reexamine commitment in insurance markets. They present an alternative model (which extends Jean-Jaques Laffont and Jean Tirole's procurement model to address uncertainty and competition), which involves semipooling in the first period followed by separation. This and competing models (e.g., single-period models and no-commitment models) have different predictions concerning temporal patterns of insurer profitability. A test using California data suggests that some automobile insurers use commitment to attract selective portfolios comprising disproportionate numbers of low risks.

This study estimates a von Neumann-Morgenstern utility function using market data and microeconometric methods. We investigate the decision whether to purchase insurance against the risk of telephone line trouble in the home. Using the choices of approximately 10,000 residential customers, we determine the shape of the utility function and the degree of risk aversion. We find that risk aversion varies systematically in the population and varies with the level of income and that the observed choice behavior is consistent with expected utility maximization.

This paper studies the evolution of a competitive industry in which a fixed number of firms reduce costs by innovating and by imitating their rivals' technologies. As the firms' technologies gradually improve, industry output expands and price falls. Technological leaders tend to rely on innovations to reduce their costs, whereas the laggards rely more on imitation. Imitation causes technology to spread from the leaders to the followers and forces some convergence of technology among firms as the industry matures. This convergence is accompanied by faster growth of smaller firms and a consequent tightening of the distribution of output over firms. Since imitation is a kind of spillover of technology, equilibrium is likely to involve insufficient innovative and imitative effort relative to a social optimum.

The late nineteenth century saw international mass migrations of capital and labor from the Old World to the New. Factors chased each other and the abundant resources at the frontier. Demographic structure also contributed to the massive capital flows from Britain to the New World. The dependency hypothesis is confirmed by estimation of savings functions in three New World economies (Argentina, Australia, and Canada) in which high dependency rates may have significantly depressed domestic savings rates and pulled in foreign investment: in effect an intergenerational transfer from old savers in the Old World to young savers in the New.

We characterize optimal enforcement in a setting in which individuals can select among various levels of some activity, all of which are monitored at the same rate but may be prosecuted and punished at varying rates. For less harmful acts, marginal expected penalties ought to fall short of marginal harms caused. Indeed, some range of very minor acts should be legalized. For more harmful acts, whether marginal expected penalties should fall short of, or exceed, marginal harms depends on the balance between monitoring and prosecution/punishment costs. We also explore how the optimal enforcement policy varies with changes in these costs.

The authors develop a model in which a large investor has access to a costly monitoring technology affecting securities' expected payoffs. Allocations of shares are determined through trading among risk-averse investors. Despite the free-rider problem associated with monitoring, risk-sharing considerations lead to equilibria in which monitoring takes place. Under certain conditions, the equilibrium allocation is Pareto efficient and all agents hold the market portfolio of risky assets independent of the specific monitoring technology. Otherwise, distortions in risk sharing may occur and monitoring activities that reduce the expected payoff on the market portfolio may be undertaken.

We focus on the effect of state versus private ownership on the rates of firm-specific productivity growth and cost decline by developing a model of endogenous, firm-specific productivity growth and testing its implications against panel data on 23 international airlines of varying levels of state ownership over the period 1973-83. Our model and empirical results show that state ownership can lower the long-run annual rate of productivity growth or cost decline, but not necessarily their levels in the short run. Observed level differences in productive efficiency across private and state-owned firms may thus be a function of the age distribution of the firms being compared. These results appear to be independent of whether the firms operate under apparently more or less competitive or regulated markets and whether they differ in production scales. The analysis offers new insights concerning the recent trend toward privatizing state-owned enterprises that has been observed in many countries.

This paper tests an optimal (S, s) rule in household durable purchases and examines directly the resulting aggregate expenditure dynamics. The observed decision rule responds to income uncertainty and growth as predicted by an (S, s) model resulting from transactions costs. Tests against liquidity constraints find that about half the households purchase according to an optimal (S, s) rule. Aggregating the (S, s) rule over households produces a cross-section distribution of durables holdings. The empirical distribution is similar to that predicted theoretically, as is its response to aggregate shocks. Furthermore, simulations of aggregate expenditure based on the household distribution exhibit dynamics consistent with those observed in the 1980s.