AER (June 2010)

The latest volume of the American Economic Review (link to the table of contents) just arrived by mail. One may get interested in the lead-off articles written by the Nobel laureates 2009 in Economic Sciences:
"Beyond Markets and States: Polycentric Governance of Complex Economic Systems" by Elinor Ostrom
"Transaction Cost Economics: The Natural Progression" by Oliver E. Williamson
Other articles that attracted my interest are the following:
  • "A Study of the Internal Organization of a Bidding Cartel" by John Asker
  • "Bargaining with Arrival of New Traders" by William Fuchs and Andrzej Skrzypacz
  • "The Burden of the Nondiversifiable Risk of Entrepreneurship" by Robert E. Hall and Susan E. Woodward
  • "What Causes Industry Agglomeration? Evidence from Coagglomeration Patterns" by Glenn Ellison, Edward L. Glaeser and William R. Kerr
I downloaded the pdf files of the above articles, trying to read them on the way to Brazil tomorrow, where I will attend a great game theory conference: The Second Brazilian Workshop of the Game Theory Society (BWGT2010, link).


Great statistician passed away

I heard a sad news: Eminent statistician David Blackwell has died at 91

Professor Blackwell, though a mathematician or statistician, is quite famous to us economists for his significant contribution in mathematical statistics and dynamic programming.
Here is a link to the wikipedia article about him.

He has written many influential papers such as:
  • "Conditional Expectation and Unbiased Sequential Estimation," Annals of Mathematical Statistics, Vol. 18, No. 1 (Mar., 1947), pp. 105-110
  • "Equivalent Comparisons of Experiments," Annals of Mathematical Statistics, Vol. 24, No. 2 (Jun., 1953), pp. 265-272  
  • "Discounted Dynamic Programming," Annals of Mathematical Statistics, Vol. 36, No. 1 (Feb., 1965), pp. 226-235

Interestingly, despite his deep thoughts and ingenious works on each research topic, he described himself as follows:
I've worked in so many areas—I'm sort of a dilettante. Basically, I'm not interested in doing research and I never have been.

May he rest in peace.


IO Seminar (Daughety and Reinganum)

Original article (link) posted: 21/09/2005

Daughety and Reinganum "Imperfect Competition and Quality Signaling"

The paper investigates the one-shot oligopoly model where firms produce substitute products with associated vertical quality measure. Each firm has private information about its quality (="type") and signaling effects by pricing are captured. Their main focus is comparison between separating equilibria of incomplete information (about vertical quality) and that of complete information.
As main results, they show the following;

1) incomplete information (signaled via prices) softens price competition, and imperfect competition can reduce the degree to which firms distort their prices to signal their types
2) low-quality firms always prefer playing the incomplete information game to the full-information analog
3) if the proportion of high-quality firms is great enough, they also prefer incomplete information to full-information

It is very difficult for me to judge their contribution in this field because there are so many papers in the literature and some of them look quite similar to this paper at least for those who are not familiar with this line of research. The model in the paper tries to capture the both effects of incomplete information and imperfect competition, which makes it very complicated. Although the main results mentioned above sound interesting, similar kind of qualitative results can be derived in simpler model I guess. For example, the comparison between a separating equilibrium and a pooling one in a simple Spence type signaling model has the implications quite similar to (2) and (3). Of curse, except for the results (1)-(3), they show a bunch of comparative static and some of them are interesting and not obvious. However, I would like to say it should be needed for them to say why such a complicated model is used to explain the results most of which were already known and hence not surprising.
The literature review (Section 2) is comprehensive. So, if you are interested in the paper, it might be better to read some key references before deeply tackle this paper.

Interesting papers in References

Bagwell and Riordan (1991) "High and Declining Prices Signal Product Quality" AER, 81
Mailath (1989) "Simultaneous Signaling in an Oligopoly Model" QJE, 104
Martin (1995) "Oligopoly Limit Pricing: Strategic Substitutes, Strategic Complements" IJIO, 13


Grossman (1989)

Original article (link) posted: 20/09/2005

I was taking a look at Sanford Grossman's book "The Informational Role of Prices". This is a collection of his articles focusing on informational role of prices or that of contracts. All the articles except for the first one were reprinted from journals. Here, I take a memo for the chapter one which is an introduction of the book.

The main theme of the book is to propose models which incorporate two aspects of the role of prices at the same time. He says;

I have elaborated a model of economic equilibrium that is based upon the idea that prices have a dual role: They constrain behavior by affecting the costs or benefits of acts, but they also convey information about what will be the costs and benefits of the acts.

In the framework of Marshall or Walras, people are merely constrained by prices, and so, no one learns anything from prices. That is, their models cannot capture the second role of prices. To be more precise, in the Walrasian model, the demand function specifies a desired level of holdings of the security at each particular price, irrespective of whether that price is a market clearing price. However, a trader might be induced to adjust his "demand" function to reflect the fact that the price at which market clears conveys information. To take this informational role into account, the author assumes that the consumer faces a price that is a real offer of another person, or the outcome of a market process.
In short, his idea is to redefine the "demand" as an expression of desired holdings at prices that are "market clearing", i.e., each consumer chooses his demand at "p" to maximize his expected utility conditioned on both his private information and on the information contained in the event that "p" is a market clearing price. As a consequence, there is no desire to recontract after observing that a particular price is the market clearing price because each person has already incorporated it.
In the rest of the chapter 1, the author introduces the concept of "uninformed traders" or "noise traders" who demand a security for noninformational reasons. Incorporating them into his models, he tries to explain the stock market crush in 1987. Interestingly, he claims this event supports his models with rational agents rather than irrational behavior of traders, which is described as follows.

Some have suggested that this is strong evidence against investor rationality, and point to the October 1987 episode as another example of irrational behavior. In contrast, I think that these events and the excessive volatility of stock prices relative to the volatility of expected payoffs are evidence in favor of the type of "rationality" embodied in the R.E. approach outlined above, rather than evidence for irrationality. As I argue below, once the Walrasian notion of demand is eliminated, the volatility phenomena can be seen as an expression of a sophisticated trading strategy rather than irrationality.

Interesting papers in References

Grossman and Stiglitz (1976) "Information and Competitive Price Systems" AER, 66-2
Kreps (1988) "In Honor of Sandy Grossman, Winner of the John Bates Clark Medal" J. of Economic Perspectives, 2-2
Kyle (1985) "Continuous Auctions and Insider Trading" Econometrica, 53
Roll (1984) "Orange Juice and Weather" AER, 74

The following book might be useful for those who are interested in the line of research mentioned above.

Brunnermeier (2001) "Asset Pricing under Asymmetric Information" Oxford University Press


IO Seminar (Rob and Fishman)

Original article (link) posted: 14/09/2005

Rob and Fishman "Is Bigger Better? Customer base expansion through word of mouth reputation" forthcoming in JPE

The paper develops a modeling framework in which a firm regards its reputation as a capital assets whose value is maintained through a process of active and continuous investment. Firms are required to investment for each period to produce high quality products. The quality of the product is only known to a consumer who buys it from the firm (experience good assumption), and she will tell this information to a new consumer with some probability. This information spread captures "word of mouth reputation".

Their main finding is that investment in quality is positively related to the size of customer base which is defined as the number of consumers who are aware of the firm's reputation. This is because reputation is costly to acquire and takes a long time to regain once it has been lost, and hence, a good reputation is more valuable to a firm the larger its customer base is. The model predicts that the larger is a firm, the more it invests in quality, and the higher is the average quality it delivers.

Interesting papers in references

Horner (2002) "Reputation and Competition" AER, 92
Mailath and Samuelson (2001) "Who wants a Good Reputation" RES, 68
Shapiro (1983) "Premiums for High Quality Products as Returns to Reputation" QJE, 98
Tadelis (2002) "The Market for Reputation as an Incentive Mechanism" JPE, 92

Their contribution in the literature is stated as follows.

What differentiates our approach from all these papers is that reputation in our model spreads in the market through word of mouth, or referrals - consumers tell other consumers about their experience, causing some firms to grow and other firms to decline. As a consequence, a firm starts out small, grows gradually, and changes its investment as its reputation is established. These interrelated processes of firm growth, reputation formation, and the links between age, size, and investment in quality represent our main contribution to the literature.


Lecture 1 (Dutta): Math Preliminaries

Original article (link) posted: 13/09/2005

The class by professor Dutta started with mathematical preliminaries. It might be good to study those concepts and some theorem again because I left myself unclear of some of them during taking a math class in my first year.
Well, I am thinking to write a brief summary for each week (The class is once every week on Monday). Here is the first one.

Topics in the class

1) Correspondings and Maximum Theorem
2) Contraction Mapping Theorem

What we covered in the class

In (1):
(a) The definitions of correspondings and several versions of continuities: upper semi-continuity (USC), lower semi-continuity (LSC) (and continuity).
(b) Maximum Theorem and its proof. Note) Maximum Theorem says that the maximum value is continuous and the maximizer is USC in parameters under some conditions.

In (2):
(c) The def. of contraction, Cauchy sequences and complete metric space.
(d) Contraction Mapping Theorem and its proof. Note) The theorem says that if there is a contraction corresponding and its domain is a complete metric space, then there exists a unique fixed point.


(a) I've often mixed up USC and LSC, but finally the difference seems to be clear for me.
(b) I need to reconsider the proof. It's not so complicated but not that easy either.
(c) I realized that I had forgotten the def. of complete metric space...
(d) The proof is much easier than (b). Uniqueness is almost straight forward.

Recommended readings

SLP Chapter 3
Sundaram (1995) "A Course in Optimization Theory"


Microeconomic Analysis - G6218

Original article (link) posted: 13/09/2005

Today, I attended the first class of G6218 which is an advanced microeconomics for upper class students by Professor Dutta. The course covers basic issues in dynamic economics and consists of the following three parts.

1) Dynamic Programming: The theory of single-agent models
2) Repeated/Dynamic Games: The theory of multi-agent models
3) Application: A strategic analysis of climate change

Although there is no required textbook, the two books listed below seems to be useful.

Stokey, Lucas and Prescott (1989) "Recursive Methods in DYnamic Economics" for (1)
Fudenberg and Tirole (1991) "Game Theory" for (2)

Since professor Dutta is very good at teaching and the topics are interesting for me and deep in mathematics, I am thinking to take this course. It should be better to bring SLP from Princeton... (I asked my friends in Princeton to keep my books.)



Here comes a great news!
Online issues of the Journal of Economic Perspectives published since 1999 are now publicly accessible at no charge, compliments of the American Economic Association.
You can access to the Journal of Economic Perspectives from here. The symposium in the latest volume (Spring 2010), Con out of Economics, contains interesting debate among leading econometricians that may attract much attention.