Knowledge that Transforms

Central to the quantity theory of money are a number of important propositions about the long-run equilibrium effects of changes in the nominal stock of money on other economic variables. A standard way of testing these propositions is to use quarterly or annual data, explicitly model the lag structure and then derive the long-run solution of the model from the empirical estimates. An alternative is to use some type of smoothing procedure to approximate positions of equilibrium and then to use these transformed data directly in testing hypotheses. The National Bureau technique of averaging data over reference cycle phases is one such method; Robert Lucas's application of Fourier transforms in Two Illustrations of the Quantity Theory of Money (1980) is another; and John Geweke's method (1982) of frequency decomposition is a third. An entirely different way of approaching the problem is to use cross-country-average rather than time-series data as the basic units of observation. The advantage, according to Lucas, is that, Since the two quantity-theoretic laws [that he examines] are obtained as characteristics of steady states, or limiting distributions, of theoretical models, the ideal experiment for testing them would be a comparison of long-term average behavior across economies with different monetary policies but similar in other respects (p. 1006). In this paper I conduct such an experiment. The data that I use are for 20 OECD countries over the period 1956-80. The specific relationships that I examine are those between money and the price level, money and real income, money and interest rates, and money and exchange rates. In the main the data accord well with the quantity-theoretic model. Classical neutrality holds. There is evidence of a Fisher effect, albeit a less than complete effect, on interest rates. Finally, the data are consistent with long-run purchasing power parity and, hence, correspondingly with a long-run monetary approach to exchange rate determination.

In an article in this Review, Arthur Raviv (1979) examines Pareto optimal insurance policies when an insurer incurs settlement costs C induced by indemnity for loss x. Raviv's main result is that a necessary and sufficient condition for the Pareto optimal deductible to equal zero is C'(I) = 0. This implies that deductible policies give the best tradeoff between risk sharing and economizing on costly claim settlements. Since in practice these costs are significant, the theorem is of considerable importance. Among others, this has been recognized by Robert Townsend (1979), Michael Brennan and Ray Solanki (1981), David Mayers and Clifford Smith (1981), Gur Huberman, Mayers, and Smith (1983), Harris Schlesinger (1981), and Stuart Turnbull (1983). The theorem is correct, but Raviv's proof is not. In this note a corrected proof for the theorem is given. The corrected proof is important in itself because it allows for a generalization to a greater variety of transactions costs than has previously been considered (see my 1984 paper for details). Section I develops the setting for the problem and the notation to be subsequently used. Raviv's error and the corrected proof are presented in Section II.

Arguing that the beliefs that there were no energy shortages in the US before the 1970s and that large-scale rationing requires government price controls are clearly wrong, the authors analyze the extent of the shortage, the nature of the rationing program, and the structure of the petroleum industry. They argue that regional isolation, industry concentration, and the vertical integration of the larger firms made rationing possible. In the absence of laws requiring rationing or setting prices, they focus on the hypothesis that the oil companies held prices down because they were afraid of hostile government actions. 22 references, 2 figures, 1 table.

This paper reviews events in the plain paper copier (PPC) market immediately after Xerox's monopoly ended. Xerox's behavior and that of a flood of PPC entrants are viewed through the lens of recent advances in the theory of entry and entry deterrence. The events of the early post-entry period also cast some interesting light on the theory of technological competition. The modern theory of entry deterrence rests on a simple, if not obvious, proposition. The (socially) worst industry performance is after entry, the more monopolies there will be, since the interests of the entrant and society are opposed once entry has occurred. A series of papers have considered endogenous changes in the of competition-monopolists who make their industry more competitive (conditional on entry) in order to deter potential entrants.' There are two distinct steps in the entry-deterrence argument. First, it must be possible for events during the monopoly period to affect postentry competition. Some intertemporal complication must be present, either in costs or in firm-specific demand, if the state of the industry at the time of entry is to form important conditions for competition. Second, the monopolist must find it profitable to manipulate the initial by some pre-entry action. The general theoretical questions of entry and deterrence have been cast in quite specific terms for the problem of technological competition. One view emphasizes the (Kenneth Arrow, 1962; Jennifer Reinganum, 1983; Drew Fudenberg and Jean Tirole). Because any innovation destroys some of the rents to older products and processes, incumbent monopolists have a smaller incentive to innovate than potential entrants. Another view (Richard Schmalensee, 1983; Richard Gilbert and David Newbery, 1982) points out that the incumbent's losses from entrant's innovation create a motive for preemptive R&D, product introduction, or patenting. If incumbents are leaders and entrants followers, the second view will hold independent of technology. Note that the difference is over the profitability of entry deterring strategies. In both views, the presence of valuable assets like patents or secrets provides the necessary intertemporal link. Events in the PPC market during the time of Xerox's monopoly did have a substantial impact on the nature of competition in the early postentry period. An Arrow effect is evident, as are other equilibrium explanations of Xerox's rapid decline. The alternative explanation that Xerox was fat is also considered below.

In this paper, we investigate the complementary question of the optimal durability of highways. We find that in order to minimize discounted lifetime costs, typical urban interstate highways should be designed with thicker pavements lasting much longer between repavings. Furthermore, although existing roads have marginal pavement-wear costs that are quite high, optimal high-volume urban interstates would not. Thus the need for marginal-cost taxation, and the accompanying diversion of trucking industry revenues, would be virtually eliminated on a large portion of the nation's highway network if the highways were built to optimal standards. We begin by reformulating the standard model of optimal highway pricing and investment (see Winston, 1985, p. 78) to include highway durability as a long-run decision variable. The resulting pricing rule includes both a congestion charge related to scarce capacity, and a heavy-vehicle charge related to scarce durability. We derive expressions for marginal-cost user charges, optimal capacity, optimal durability, and long-run marginal pavement-wear cost. We then explore empirically those parts of the model related to durability.

Stiglitz and Shapiro tackle the problem of unemployment.