Original article (link) posted: 04/11/2005
Gowrisankaran and Rysman "Dynamics of Consumer Demand for New Durable Consumer Goods"
The paper proposes a dynamic model of consumer preferences for new consumer durable goods and estimates it. Consumers in their model are heterogeneous. They are assumed to choose between purchasing a current product and waiting for future products, making rational forecasts about the future distribution of prices and qualities. Two actual industries, DVD players and digital cameras are estimated.
Comment
The model seems to be attractive because it examines dynamic aspects and heterogeneity of consumers that have not been done successfully in the literature, although everyone agrees the importance. I am bit wondering if incorporating the uncertain of the future markets has serious effects to the estimated results or not. In their model, consumers fully know when and what kind of products will appear. However, if the future market is uncertain in the sense that consumers only know the probability distribution of future products, there might be an additional waiting value. That is, consumers may be better off by postponing their purchase to resolve uncertainty. This option value of waiting is known as "Real Option" in finance. In real world, the arrival of new products typically depends on the result of R&D investments which is presumably stochastic. So, even firms cannot exactly know the schedule of future products in many cases. Therefore, to incorporate future uncertainty is an important extension I think.
Showing posts with label industrial organization. Show all posts
Showing posts with label industrial organization. Show all posts
2014-03-18
2011-05-10
A Maskin's IO paper
Original article (link) posted: 30/10/2005
Maskin (1999) “Uncertainty and entry deterrence” Economic Theory, 14
A model where capacity installation by an incumbent firm serves to deter others from entering the industry is considered. The paper shows that uncertainty about demand or costs forces the incumbent to choose a higher capacity level than it would under certainty. The intuitive reason is explained in Introduction, which is stated as follows;
To deter entry, the incumbent must install enough capacity so that, if entry occurred, the entrant’s profit would be zero (or negative). Under certainty, the incumbent will install no more capacity than it would use were entry to occur. With uncertainty, when demand is high, an incumbent that has installed the certainty level of capacity still continues to produce at capacity; price simply rises to reflect the higher demand. But, when demand is low, the incumbent will wish to produce at less than full capacity. This means that the fall in price when demand is low is not so large as the rise in price when demand is high, and so if the entrant’s is zero under certainty, it is positive with certainty. To deter entry, therefore, the incumbent must increase capacity above the certainty level to ensure that when demand is high it produces enough to drive the entrant’s expected profit back down to zero.
Maskin (1999) “Uncertainty and entry deterrence” Economic Theory, 14
A model where capacity installation by an incumbent firm serves to deter others from entering the industry is considered. The paper shows that uncertainty about demand or costs forces the incumbent to choose a higher capacity level than it would under certainty. The intuitive reason is explained in Introduction, which is stated as follows;
To deter entry, the incumbent must install enough capacity so that, if entry occurred, the entrant’s profit would be zero (or negative). Under certainty, the incumbent will install no more capacity than it would use were entry to occur. With uncertainty, when demand is high, an incumbent that has installed the certainty level of capacity still continues to produce at capacity; price simply rises to reflect the higher demand. But, when demand is low, the incumbent will wish to produce at less than full capacity. This means that the fall in price when demand is low is not so large as the rise in price when demand is high, and so if the entrant’s is zero under certainty, it is positive with certainty. To deter entry, therefore, the incumbent must increase capacity above the certainty level to ensure that when demand is high it produces enough to drive the entrant’s expected profit back down to zero.
2011-03-09
R&D investments and the persistence of monopoly
Original article (link) posted: 26/10/2005
R&D-intensive industries are natural context in which to address the following questions; “Do dominant firms tend to maintain, or even increase, their market dominance?” and “Is market power temporary or is it permanent?”
Gilbert and Newbery (1982) develop a strong argument in the view of persistence of incumbency. They claim that a monopolist has more to lose from letting competition in than a potential entrant has from challenging the monopolist. As a result, the tendency should be towards persistence, not alternation, of market dominance. Interestingly enough, they relate their model to a model of an auction market and state that preemption is a Nash equilibrium of the corresponding auction game. (A monopolist has higher willingness to pay than that of an entrant and hence bids higher amount. I think this result can be quoted in my license auctions paper.)
Reinganum (1982) makes the point that Gilbert and Newbery’s result depends on their assumptions on the deterministic process of R&D. She shows that with uncertainty, there are cases when the probability the monopolist is replaced by an entrant is greater than the probability of persistence, hence R&D would decrease the market dominance. Her logic is as follows. Under uncertainty, with positive probability, the potential entrant does not succeed in inventing a new product, even though it invests a positive amount. When this happens, a successful incumbent would only be replacing its monopoly product with another monopoly product. Because of this “replacement” effect, a monopolist has less incentive to engage in R&D that a competitive firm has.
References
Gilbert and Newbery (1982) “Preemptive Patenting and the Persistence of Monopoly” AER, 72
Reinganum (1982) “Uncertain Innovation and the Persistence of Monopoly” AER, 73
R&D-intensive industries are natural context in which to address the following questions; “Do dominant firms tend to maintain, or even increase, their market dominance?” and “Is market power temporary or is it permanent?”
Gilbert and Newbery (1982) develop a strong argument in the view of persistence of incumbency. They claim that a monopolist has more to lose from letting competition in than a potential entrant has from challenging the monopolist. As a result, the tendency should be towards persistence, not alternation, of market dominance. Interestingly enough, they relate their model to a model of an auction market and state that preemption is a Nash equilibrium of the corresponding auction game. (A monopolist has higher willingness to pay than that of an entrant and hence bids higher amount. I think this result can be quoted in my license auctions paper.)
Reinganum (1982) makes the point that Gilbert and Newbery’s result depends on their assumptions on the deterministic process of R&D. She shows that with uncertainty, there are cases when the probability the monopolist is replaced by an entrant is greater than the probability of persistence, hence R&D would decrease the market dominance. Her logic is as follows. Under uncertainty, with positive probability, the potential entrant does not succeed in inventing a new product, even though it invests a positive amount. When this happens, a successful incumbent would only be replacing its monopoly product with another monopoly product. Because of this “replacement” effect, a monopolist has less incentive to engage in R&D that a competitive firm has.
References
Gilbert and Newbery (1982) “Preemptive Patenting and the Persistence of Monopoly” AER, 72
Reinganum (1982) “Uncertain Innovation and the Persistence of Monopoly” AER, 73
2011-01-14
Summary of IO Papers (by O. Williamson)
Original article (link) posted:18/10/2005
Industrial Organization (edited by O. Williamson) contains 23 important IO papers in the literature. The below is the list of short summaries of selected papers written by the editor, O. Williamson which are quoted from the ‘Introduction’. Since most of the papers are still relevant and must-read for IO researchers, the list may be a helpful guide for you. Please enjoy it!
Alchian (1950) “Uncertainty, Evolution, and Economic Theory”
The paper is significant in several directions. For one thing, selection arguments play a large role in virtually all forms of long-run competitive analysis. Second, the use of simplifying assumptions of an ‘as if’ hyperrationality kind can sometimes be justified by invoking selection arguments. And third, Alchian’s treatment of evolutionary issues is insightful and is carefully nuanced.
Holmstrom (1982) “Moral Hazard in Teams”
The author extends earlier work of a principal/single-agent kind to include relations between multiple agents in teams. The paper develops a sufficient statistic condition on relative performance evaluation according to which competition among agents is not valued because it induces added effort but rather than because it is a device to extract information optimality.
Grossman and Hart (1986) “The Costs and Benefits of Ownership: A Theory of Vertical and Lateral Integration”
Although the formal modeling of incomplete contracting is formidably difficult, the paper develops a model in which both ex-ante alignment and ex post adaptation differences between market and hierarchical models of organization are recognized.
Dixit (1980) “The Role of Investment in Entry-Deterrence”
The paper sets out the basic logic and demonstrates the critical importance of investments in durable, nonredeployable assets to effect entry deterrence. Given credible pre-entry commitments, the logic of entry barriers was made secure. But inasmuch as a duopoly setup is highly specialized, the empirical significance and antitrust enforcement ramifications of the argument can be questioned.
Aghion and Bolton (1987) “Contracts as a Barrier to Entry”
What the paper examines is whether an incumbent supplier can fashion a penalty clause, the effects of which penalty make the incumbent better off. It is shown that penalties can be devised such that lower cost entrants can be deterred – although not necessarily precluded – from entering.
Milgrom and Robertes (1982) “Limit Pricing and Entry Under Incomplete Information: An Equilibrium Analysis”
The use of limit pricing here turns on an information asymmetry between the sitting monopolist (or incumbent) and the potential entrant. Whereas the incumbent knows its costs, the potential entrant can only infer them. The incumbent would like to signal to the potential entrant that it has low costs, thereby to deter entry. Although it can do this by setting a low price, the entrant is alert to the strategic nature of the game and redcognizes that signaling can be used for strategic purpose.
Kreps and Wilson (1982) “Reputation and Imperfect Information”
The paper shows that the introduction of a small amount of imperfect or incomplete information can transform such a game into one whereby monopolists strategically contest entry. The logic of unraveling gives way to a logic of reputation in an intertemporal framework into which imperfect information has been introduced.
Baumol, Pazner and Willig (1986) “On the Theory of Perfectly-Contestable Markets”
The paper summarizes the central arguments of their influential book and advances the argument that the perfectly contestable market – that in which asset-specificity is negligible, whence assets are easily redeployable to alternative uses and by alternative users – is usefully regarded as an analytical and public policy benchmark.
Salop (1979) “Monopolistic Competition with Outside Goods”
The author uses a spatial competition model to investigate monopolistic competition. Salop’s treatment nicely displays the key features of a monopolistically competitive contest in a spatial equilibrium setting.
Industrial Organization (edited by O. Williamson) contains 23 important IO papers in the literature. The below is the list of short summaries of selected papers written by the editor, O. Williamson which are quoted from the ‘Introduction’. Since most of the papers are still relevant and must-read for IO researchers, the list may be a helpful guide for you. Please enjoy it!
Alchian (1950) “Uncertainty, Evolution, and Economic Theory”
The paper is significant in several directions. For one thing, selection arguments play a large role in virtually all forms of long-run competitive analysis. Second, the use of simplifying assumptions of an ‘as if’ hyperrationality kind can sometimes be justified by invoking selection arguments. And third, Alchian’s treatment of evolutionary issues is insightful and is carefully nuanced.
Holmstrom (1982) “Moral Hazard in Teams”
The author extends earlier work of a principal/single-agent kind to include relations between multiple agents in teams. The paper develops a sufficient statistic condition on relative performance evaluation according to which competition among agents is not valued because it induces added effort but rather than because it is a device to extract information optimality.
Grossman and Hart (1986) “The Costs and Benefits of Ownership: A Theory of Vertical and Lateral Integration”
Although the formal modeling of incomplete contracting is formidably difficult, the paper develops a model in which both ex-ante alignment and ex post adaptation differences between market and hierarchical models of organization are recognized.
Dixit (1980) “The Role of Investment in Entry-Deterrence”
The paper sets out the basic logic and demonstrates the critical importance of investments in durable, nonredeployable assets to effect entry deterrence. Given credible pre-entry commitments, the logic of entry barriers was made secure. But inasmuch as a duopoly setup is highly specialized, the empirical significance and antitrust enforcement ramifications of the argument can be questioned.
Aghion and Bolton (1987) “Contracts as a Barrier to Entry”
What the paper examines is whether an incumbent supplier can fashion a penalty clause, the effects of which penalty make the incumbent better off. It is shown that penalties can be devised such that lower cost entrants can be deterred – although not necessarily precluded – from entering.
Milgrom and Robertes (1982) “Limit Pricing and Entry Under Incomplete Information: An Equilibrium Analysis”
The use of limit pricing here turns on an information asymmetry between the sitting monopolist (or incumbent) and the potential entrant. Whereas the incumbent knows its costs, the potential entrant can only infer them. The incumbent would like to signal to the potential entrant that it has low costs, thereby to deter entry. Although it can do this by setting a low price, the entrant is alert to the strategic nature of the game and redcognizes that signaling can be used for strategic purpose.
Kreps and Wilson (1982) “Reputation and Imperfect Information”
The paper shows that the introduction of a small amount of imperfect or incomplete information can transform such a game into one whereby monopolists strategically contest entry. The logic of unraveling gives way to a logic of reputation in an intertemporal framework into which imperfect information has been introduced.
Baumol, Pazner and Willig (1986) “On the Theory of Perfectly-Contestable Markets”
The paper summarizes the central arguments of their influential book and advances the argument that the perfectly contestable market – that in which asset-specificity is negligible, whence assets are easily redeployable to alternative uses and by alternative users – is usefully regarded as an analytical and public policy benchmark.
Salop (1979) “Monopolistic Competition with Outside Goods”
The author uses a spatial competition model to investigate monopolistic competition. Salop’s treatment nicely displays the key features of a monopolistically competitive contest in a spatial equilibrium setting.
2011-01-08
AER (September 2010)
The hard-copy of the American Economic Review (September 2010, link) has arrived in late December, which seems to contain lots of interesting papers (as usual). The following is the list of papers whose titles especially attracted me.
- "Morally Motivated Self-Regulation" by David Baron
- "Are Health Insurance Markets Competitive?" by Leemore Dafny
- "The Law of the Few" by Andrea Galeotti and Sanjeev Goyal
- "Monopoly Price Discrimination and Demand Curvature" by Inaki Aguirre, Simon Cowan and John Vickers
- "Strategic Redistricting" by Faruk Gul and Wolfgang Pesendorfer
- "A Price Theory of Multi-Sided Platforms" by Glen Weyl
- "When Does Communication Improve Coordination?" by Tore Ellingsen and Robert Ostling
2010-11-10
Kandori (1991)
Original article (link) posted: 01/10/2005
Kandori (1991) "Correlated Demand Shocks and Price Wars During Booms" RES, 58
The paper extends the analysis of Rotemberg and Saloner (1986) to the case of serially correlated demand shocks and derives the same counter-cyclical movement as in their case (i.i.d. case), provided the discount factor and the number of the firms satisfy certain relationship.
The key observation in Rotemberg and Saloner (1986) was that, if the sum of future profits is unaffected by today’s demand, firms must set the price relatively low when demand is high. The premise is clearly satisfied when the demand shocks are i.i.d.. This paper shows introducing Markov demand shocks also create the same situation in the following two cases. The first case is when the discount factor delta exceeds, but is close to (N-1)/N, where N is the number of the firm. It is shown that firms maintain a constant profit (which equals to the monopoly profit in the worst state) under all demand conditions. Therefore, the extent of the correlation in demand is irrelevant.
The second case arises when delta tends to unity while (1-delta)N is held constant. In this case, firms are enormously forward-looking and total future profit is mostly determined by the stationary distribution, which is independent of today’s demand position.
The result itself is not that surprising (comparing to the other papers by Kandori at least). However, he is amazingly good at selling his work, especially in the following two points;
First, he stresses the importance of Rotemberg and Saloner (1986) and their drawbacks as well. The motivation of extension of their paper becomes very clear and the reader necessarily gets interested in HIS work.
Second, his way of illustrating results is quite lucid and rigorous. Although, the results can be more or less expected to hold, it always is difficult to prove them in rigorously.
Those techniques should be useful for us. Let’s learn them by the papers by Kandori!
Interesting Papers that cite Kandori (1991)
Bagwell (2004) "Countercyclical Pricing in Customer Markets" Economica, 71
Bo (2001) "Tacit Collusion under Interest Rate Fluctuations" Job Market Paper
Harrington (2004) "Cartel Pricing Dynamics in the Presence of an Antitrust Authority" Rand
Kandori (1991) "Correlated Demand Shocks and Price Wars During Booms" RES, 58
The paper extends the analysis of Rotemberg and Saloner (1986) to the case of serially correlated demand shocks and derives the same counter-cyclical movement as in their case (i.i.d. case), provided the discount factor and the number of the firms satisfy certain relationship.
The key observation in Rotemberg and Saloner (1986) was that, if the sum of future profits is unaffected by today’s demand, firms must set the price relatively low when demand is high. The premise is clearly satisfied when the demand shocks are i.i.d.. This paper shows introducing Markov demand shocks also create the same situation in the following two cases. The first case is when the discount factor delta exceeds, but is close to (N-1)/N, where N is the number of the firm. It is shown that firms maintain a constant profit (which equals to the monopoly profit in the worst state) under all demand conditions. Therefore, the extent of the correlation in demand is irrelevant.
The second case arises when delta tends to unity while (1-delta)N is held constant. In this case, firms are enormously forward-looking and total future profit is mostly determined by the stationary distribution, which is independent of today’s demand position.
The result itself is not that surprising (comparing to the other papers by Kandori at least). However, he is amazingly good at selling his work, especially in the following two points;
First, he stresses the importance of Rotemberg and Saloner (1986) and their drawbacks as well. The motivation of extension of their paper becomes very clear and the reader necessarily gets interested in HIS work.
Second, his way of illustrating results is quite lucid and rigorous. Although, the results can be more or less expected to hold, it always is difficult to prove them in rigorously.
Those techniques should be useful for us. Let’s learn them by the papers by Kandori!
Interesting Papers that cite Kandori (1991)
Bagwell (2004) "Countercyclical Pricing in Customer Markets" Economica, 71
Bo (2001) "Tacit Collusion under Interest Rate Fluctuations" Job Market Paper
Harrington (2004) "Cartel Pricing Dynamics in the Presence of an Antitrust Authority" Rand
2010-10-19
Shapiro (1983)
Original article (link) posted: 29/09/2005
Shapiro (1983) "Premiums for High Quality Products as Returns to Reputations" QJE 98
Think about the market where producers can change product quality over time and consumers cannot observe quality prior to purchase. Then, what will happen? To answer this question, Shapiro (1983) develops a model that explores the implications of firm-specific reputations in a perfectly competitive environment. The one of the most interesting results is that in the equilibrium, firms produce higher quality products earn larger premiums. The premiums are needed for the following two reasons;
First, there is a cost to establish reputation and to offset the cost, positive return (=premium) is needed. Without a premium, no firm chooses high quality.
Second, in this market, sellers can always increase profits in the short-run by reducing the quality of their products (="fly-by-night strategy"). To prevent this deviation, positive return on the faithful path (which dominates the short-run return induced by fly-by-night strategy) is needed.
Although, the above point has already been recognized (Klein and Leffler (1981) explored this idea informally), this is the first paper which models reputation under competitive markets.
Tirole (1988) (2.6.2) provides a simplified version of the Shapiro model; one firm, and two types of qualities. He also points out two problems of Shapiro's model, which are the reliance of infinite-horizon time and bootstrap aspects of the equilibria. As is easily seen, only the lowest quality product is provided in each period with finite horizon model (by backward induction). Bootstrap aspects mean that reputation matters only because consumers believe it matters. Indeed, if, for example, consumers believe the firms produce the low quality no matter what the past history, then their expectation would again be fulfilled. In other words, the analysis suggests only that repetition may offer incentives to supply quality, not that it necessarily will.
Note) In the paper, this possibility is excluded since the author poses strong assumption about reputation formation; the expected quality of the firm's product at t is simply the product quality he chooses at t-1, i.e., R(t)=q(t-1). This simple adjustment expectation turns out to be a rational expectation. However, as Tirole mentions, there are other rational expectation equilibria and Shapiro (1983) does not mention them.
Finally, notice that Kreps and Wilson (1982) and Milgrom and Roberts (1982) showed that reputation effects can be obtained even with a finite horizon by introducing asymmetric information about firm's type. Their models also pin down the equilibrium strategy and high quality is necessarily observed.
References
Klein and Leffler (1981) "The Role of Market Forces in Assuring Contractual Performance" JPE, 81
Kreps and Wilson (1982) "Reputation and Imperfect Information" JET, 27
Milgrom and Roberts (1982) "Predation, Reputation, and Entry Deterrence" JET, 27
Tirole (1988) "The Theory of Industrial Organization" MIT Press
Shapiro (1983) "Premiums for High Quality Products as Returns to Reputations" QJE 98
Think about the market where producers can change product quality over time and consumers cannot observe quality prior to purchase. Then, what will happen? To answer this question, Shapiro (1983) develops a model that explores the implications of firm-specific reputations in a perfectly competitive environment. The one of the most interesting results is that in the equilibrium, firms produce higher quality products earn larger premiums. The premiums are needed for the following two reasons;
First, there is a cost to establish reputation and to offset the cost, positive return (=premium) is needed. Without a premium, no firm chooses high quality.
Second, in this market, sellers can always increase profits in the short-run by reducing the quality of their products (="fly-by-night strategy"). To prevent this deviation, positive return on the faithful path (which dominates the short-run return induced by fly-by-night strategy) is needed.
Although, the above point has already been recognized (Klein and Leffler (1981) explored this idea informally), this is the first paper which models reputation under competitive markets.
Tirole (1988) (2.6.2) provides a simplified version of the Shapiro model; one firm, and two types of qualities. He also points out two problems of Shapiro's model, which are the reliance of infinite-horizon time and bootstrap aspects of the equilibria. As is easily seen, only the lowest quality product is provided in each period with finite horizon model (by backward induction). Bootstrap aspects mean that reputation matters only because consumers believe it matters. Indeed, if, for example, consumers believe the firms produce the low quality no matter what the past history, then their expectation would again be fulfilled. In other words, the analysis suggests only that repetition may offer incentives to supply quality, not that it necessarily will.
Note) In the paper, this possibility is excluded since the author poses strong assumption about reputation formation; the expected quality of the firm's product at t is simply the product quality he chooses at t-1, i.e., R(t)=q(t-1). This simple adjustment expectation turns out to be a rational expectation. However, as Tirole mentions, there are other rational expectation equilibria and Shapiro (1983) does not mention them.
Finally, notice that Kreps and Wilson (1982) and Milgrom and Roberts (1982) showed that reputation effects can be obtained even with a finite horizon by introducing asymmetric information about firm's type. Their models also pin down the equilibrium strategy and high quality is necessarily observed.
References
Klein and Leffler (1981) "The Role of Market Forces in Assuring Contractual Performance" JPE, 81
Kreps and Wilson (1982) "Reputation and Imperfect Information" JET, 27
Milgrom and Roberts (1982) "Predation, Reputation, and Entry Deterrence" JET, 27
Tirole (1988) "The Theory of Industrial Organization" MIT Press
2010-10-08
IO Seminar (Kadyrzhanova)
Original article (link) posted: 28/09/2005
Kadyrzhanova "The Leader-Bias Hypothesis: Monopolization and Industry Structure under Imperfect Corporate Control" Job Market Paper
The paper examines the effect of the imperfect corporate control in a dynamic oligopoly market with cost reducing R&D investments. The managers are assumed to have an over-producing incentive ("empire-building" hypothesis), and hence, they do not maximize firms' short-run profit without intervention of the shareholders. Corporate control serves to shift managers' preference from "empire-building" to "profit maximization".
The key observation is that shareholders may want to choose imperfect control because of the commitment benefit of the over-producing derived by "empire-building" preference of the manager. Indeed, she shows that even if there is no cost of corporate control, shareholders do not choose full control. Moreover, it is shown that shareholders are more willing to leave discretionary authority to managers when ahead of rivals, which results in lower turnover, higher concentration, persistently monopolized markets, and significantly lower consumer surplus.
Comments
I found the paper quite interesting. However, there were so many things she put in her presentation and the relationship among those are not clear enough for me. I am afraid that audiences also got little because her focus of the talk is vague. I think her presentation could have become much better if she had tried the followings:
1) Stress and make clear the contribution to the literature
2) Put more intuitive explanation of the main results
3) Be more confident on mathematical parts
4) Mention some actual story in markets or empirical facts as a motivation
5) Explain which element of the model is a key to derive the corresponding result
Interesting Papers in Reference
Athey and Schmutzler (2001) "Investment and Market Dominance" RAND 32 (1): 1-26
Bagwell, Ramey and Spulber (1997) "Dynamic Retail Price and Investment
Competition" Rand, 28(2), 207-227
Bolton, Brodley, and Riordan (2000) "Predatory Pricing: Strategic Theory and Legal Policy" Georgetown Law Journal, 88, pp. 2239-2330
Bolton and Scharfstein (1990) "A Theory of Predation Based on Agency Problems in Financial Contracting" American Economic Review 80(1): 93-106
Cabral and Riordan (1994) "The Learning Curve, Market Dominance and Predatory Pricing" Econometrica, 62, pp. 1115-1140
Fershtman and Judd (1987) "Equilibrium Incentives in Oligopoly" American Economic Review, 77(5), 927-940
Kadyrzhanova "The Leader-Bias Hypothesis: Monopolization and Industry Structure under Imperfect Corporate Control" Job Market Paper
The paper examines the effect of the imperfect corporate control in a dynamic oligopoly market with cost reducing R&D investments. The managers are assumed to have an over-producing incentive ("empire-building" hypothesis), and hence, they do not maximize firms' short-run profit without intervention of the shareholders. Corporate control serves to shift managers' preference from "empire-building" to "profit maximization".
The key observation is that shareholders may want to choose imperfect control because of the commitment benefit of the over-producing derived by "empire-building" preference of the manager. Indeed, she shows that even if there is no cost of corporate control, shareholders do not choose full control. Moreover, it is shown that shareholders are more willing to leave discretionary authority to managers when ahead of rivals, which results in lower turnover, higher concentration, persistently monopolized markets, and significantly lower consumer surplus.
Comments
I found the paper quite interesting. However, there were so many things she put in her presentation and the relationship among those are not clear enough for me. I am afraid that audiences also got little because her focus of the talk is vague. I think her presentation could have become much better if she had tried the followings:
1) Stress and make clear the contribution to the literature
2) Put more intuitive explanation of the main results
3) Be more confident on mathematical parts
4) Mention some actual story in markets or empirical facts as a motivation
5) Explain which element of the model is a key to derive the corresponding result
Interesting Papers in Reference
Athey and Schmutzler (2001) "Investment and Market Dominance" RAND 32 (1): 1-26
Bagwell, Ramey and Spulber (1997) "Dynamic Retail Price and Investment
Competition" Rand, 28(2), 207-227
Bolton, Brodley, and Riordan (2000) "Predatory Pricing: Strategic Theory and Legal Policy" Georgetown Law Journal, 88, pp. 2239-2330
Bolton and Scharfstein (1990) "A Theory of Predation Based on Agency Problems in Financial Contracting" American Economic Review 80(1): 93-106
Cabral and Riordan (1994) "The Learning Curve, Market Dominance and Predatory Pricing" Econometrica, 62, pp. 1115-1140
Fershtman and Judd (1987) "Equilibrium Incentives in Oligopoly" American Economic Review, 77(5), 927-940
2010-07-18
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
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
2010-07-11
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.
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.
2010-06-28
Kamien (Handbook of GT 1992)
Original article (link) posted: 12/09/2005
Kamien (1992) "Patent Licensing" Handbook of Game Theory, vol.1, chapter 11
This survey focuses on game-theoretic analysis of patent licensing. In the paper, the interaction between a patentee and licensees is described in terms of a three-stage game. In the first stage, a patentee sells the patent by using some mechanism. Firms in the industry simultaneously decide their buying strategies in the next stage. And finally, patents are distributed according to the rule of a mechanism and market competition (Cournot competition) is realized.
The main focus on the paper is comparison between different mechanisms which are (1) auction (2) fixed fee licensing (3) royalty (4) hybrid of (2)&(3). The interesting result is that licensing auction yields higher revenue than fixed fee or royalty does. In some situations, however, the hybrid mechanism colled "chutzpah" mechanism yields even higher revenue than auction does.
The analyses introduced in this survey has several restrictions such as; no private information, identical firms, only considering profit maximization.
In the end, the paper concludes as follows.
It is often the case that a survey of a line of research is a signal of it having peaked. This is certainly not true for game-theoretic analysis of paten licensing.
I hope this comment is still true although it has been written in 15 year ago...
Interesting Papers on References
Jensen (1989) "Reputational spillovers, innovation, licensing and entry" IJIO, 10-2
Katz and Shapiro (1985) "On the licensing of innovation" Rand, 16
Katz and Shapiro (1986) "How to license intangible property" QJE, 101
Muto (1987) "Possibility of relicensing and patent protection" EER, 31
Reinganum (1989) "The timing of innovation: Research, development and diffusion" in Handbook of IO
Kamien (1992) "Patent Licensing" Handbook of Game Theory, vol.1, chapter 11
This survey focuses on game-theoretic analysis of patent licensing. In the paper, the interaction between a patentee and licensees is described in terms of a three-stage game. In the first stage, a patentee sells the patent by using some mechanism. Firms in the industry simultaneously decide their buying strategies in the next stage. And finally, patents are distributed according to the rule of a mechanism and market competition (Cournot competition) is realized.
The main focus on the paper is comparison between different mechanisms which are (1) auction (2) fixed fee licensing (3) royalty (4) hybrid of (2)&(3). The interesting result is that licensing auction yields higher revenue than fixed fee or royalty does. In some situations, however, the hybrid mechanism colled "chutzpah" mechanism yields even higher revenue than auction does.
The analyses introduced in this survey has several restrictions such as; no private information, identical firms, only considering profit maximization.
In the end, the paper concludes as follows.
It is often the case that a survey of a line of research is a signal of it having peaked. This is certainly not true for game-theoretic analysis of paten licensing.
I hope this comment is still true although it has been written in 15 year ago...
Interesting Papers on References
Jensen (1989) "Reputational spillovers, innovation, licensing and entry" IJIO, 10-2
Katz and Shapiro (1985) "On the licensing of innovation" Rand, 16
Katz and Shapiro (1986) "How to license intangible property" QJE, 101
Muto (1987) "Possibility of relicensing and patent protection" EER, 31
Reinganum (1989) "The timing of innovation: Research, development and diffusion" in Handbook of IO
2010-06-12
A note on Abreu (1986)
Original article (link) posted: 20/08/2005
There has been no systematic attempt to study the maximal degree of collusion sustainable by credible threats for arbitrary values of the discount factor. In view of the motivation for moving from static to repeated models, this has some claims to being the essential question at issue.
As argued by Abreu (1983, Ph.D thesis), the fundamental determinant of the limits of collusion is the severity of punishments with which potential deviants from cooperative behavior can credibly be threatened. Accordingly, this paper concentrates principally on characterizing strategy profiles which yield optimal (in the sense of most severe) punishments.
A particular class of paths called two-phase punishments plays a central role. A two-phase punishment is symmetric; in addition it is stationary after the first period, i.e., in the second phase. I show that the optimal two-phase punishment is:
(1) Globally optimal for a certain range of parameter values.
(2) An optimal symmetric punishment.
(3) More severe than Cournot-Nash reversion.
(4) Easily calculated. (It is completely characterized by a pair of simultaneous equations.)
(5) The second phase of the optimal two-phase punishment is the most collusive symmetric output level which can be sustained by the optimal two-phase punishment itself.
...
(5) says that the optimal two-phase punishment consists of a stick and carrot; furthermore, the carrot phase is the most attractive collusive regime which can credibly be offered when optimal two-phase punishments are used to deter defections. Thus when we solve for optimal two-phase punishments, we simultaneously determine the maximal degree of collusion sustainable by optimal symmetric punishments. It is worth remarking that the stick-and-carrot property is not a curiosum, but arises naturally from the structure of the problem.
Optimal asymmetric punishments have a rather complicated structure and thus far elude description as complete as that provided for optimal symmetric punishments in the earlier section.
(All quoted from Abreu (1986))
I would like to say something about asymmetric cases below.
For delta large enough, optimal symmetric punishments yield 0 payoff hence they are the most severe punishment (notice that a firm's minmax payoff in the component game is zero). And in this case, all firms simultaneously minmax one another in the first phase of the punishment.
However, if an optimal symmetric punishment yields firms positive payoffs (more than their minmax payoffs), then it is not globally optimal.
Abreu gives characterizations of optimal asymmetric punishments. But they are complicated and much less sharper than those with symmetric cases.
There has been no systematic attempt to study the maximal degree of collusion sustainable by credible threats for arbitrary values of the discount factor. In view of the motivation for moving from static to repeated models, this has some claims to being the essential question at issue.
As argued by Abreu (1983, Ph.D thesis), the fundamental determinant of the limits of collusion is the severity of punishments with which potential deviants from cooperative behavior can credibly be threatened. Accordingly, this paper concentrates principally on characterizing strategy profiles which yield optimal (in the sense of most severe) punishments.
A particular class of paths called two-phase punishments plays a central role. A two-phase punishment is symmetric; in addition it is stationary after the first period, i.e., in the second phase. I show that the optimal two-phase punishment is:
(1) Globally optimal for a certain range of parameter values.
(2) An optimal symmetric punishment.
(3) More severe than Cournot-Nash reversion.
(4) Easily calculated. (It is completely characterized by a pair of simultaneous equations.)
(5) The second phase of the optimal two-phase punishment is the most collusive symmetric output level which can be sustained by the optimal two-phase punishment itself.
...
(5) says that the optimal two-phase punishment consists of a stick and carrot; furthermore, the carrot phase is the most attractive collusive regime which can credibly be offered when optimal two-phase punishments are used to deter defections. Thus when we solve for optimal two-phase punishments, we simultaneously determine the maximal degree of collusion sustainable by optimal symmetric punishments. It is worth remarking that the stick-and-carrot property is not a curiosum, but arises naturally from the structure of the problem.
Optimal asymmetric punishments have a rather complicated structure and thus far elude description as complete as that provided for optimal symmetric punishments in the earlier section.
(All quoted from Abreu (1986))
I would like to say something about asymmetric cases below.
For delta large enough, optimal symmetric punishments yield 0 payoff hence they are the most severe punishment (notice that a firm's minmax payoff in the component game is zero). And in this case, all firms simultaneously minmax one another in the first phase of the punishment.
However, if an optimal symmetric punishment yields firms positive payoffs (more than their minmax payoffs), then it is not globally optimal.
Abreu gives characterizations of optimal asymmetric punishments. But they are complicated and much less sharper than those with symmetric cases.
2010-06-07
Price Rigidities
Original article (link) posted: 16/08/2005
In reality, prices cannot be adjusted continuously.
...
On the demand side, past prices may affect the firms' current goodwill through consumers' learning about the good or switching costs. On the supply side, past prices affect current inventories.
...
The presence of price rigidities raises the possibility that price reactions are not bootstrap reactions but are simply attempts to regain or consolidate market share.
(Tirole (1988), p.253-4)
In Maskin and Tirole (1988), they assume two firms choose their prices asynchoronously, at odd (even) periods, firm 1 (2) chooses its price. They consider Markov strategies, the simple pricing strategies that depend only on the "payoff-relevant information", and look for a perfect equilibrium in which the firms use Markov strategies. (They call it "Markov perfect equilibrium")
Despite the restriction to simple (Markov) strategies, multiple equilibria exist (indeed, there also exist several kinked-demand-curve equilibria). However, it can be shown that in any Markov perfect equilibrium, profits are always bounded away from the competitive profit (which is 0).
...
The intuition here is that if firms were stuck in the competitive price region, with the prospects of small profits in the future, a firm could raise its price dramatically and lure its rival to charge a high price for at least some time (the rival would not hurry back to nearly competitive prices). Thus tacit collusion is not only possible (as in the supergame approach) but necessary. Furthermore, it can be shown that there exists only one pair of equilibrium strategies that sustain industry profits close to the monopoly profit. These strategies from a symmetric kinked-demand-curve equilibrium at the monopoly price, and they are the only symmetric "renegotiation-proof" equilibrium strategies (whatever the current price, the firms cannot find an alternative Markov perfect equilibrium that they both prefer).
(Tirole (1988), p.256)
In reality, prices cannot be adjusted continuously.
...
On the demand side, past prices may affect the firms' current goodwill through consumers' learning about the good or switching costs. On the supply side, past prices affect current inventories.
...
The presence of price rigidities raises the possibility that price reactions are not bootstrap reactions but are simply attempts to regain or consolidate market share.
(Tirole (1988), p.253-4)
In Maskin and Tirole (1988), they assume two firms choose their prices asynchoronously, at odd (even) periods, firm 1 (2) chooses its price. They consider Markov strategies, the simple pricing strategies that depend only on the "payoff-relevant information", and look for a perfect equilibrium in which the firms use Markov strategies. (They call it "Markov perfect equilibrium")
Despite the restriction to simple (Markov) strategies, multiple equilibria exist (indeed, there also exist several kinked-demand-curve equilibria). However, it can be shown that in any Markov perfect equilibrium, profits are always bounded away from the competitive profit (which is 0).
...
The intuition here is that if firms were stuck in the competitive price region, with the prospects of small profits in the future, a firm could raise its price dramatically and lure its rival to charge a high price for at least some time (the rival would not hurry back to nearly competitive prices). Thus tacit collusion is not only possible (as in the supergame approach) but necessary. Furthermore, it can be shown that there exists only one pair of equilibrium strategies that sustain industry profits close to the monopoly profit. These strategies from a symmetric kinked-demand-curve equilibrium at the monopoly price, and they are the only symmetric "renegotiation-proof" equilibrium strategies (whatever the current price, the firms cannot find an alternative Markov perfect equilibrium that they both prefer).
(Tirole (1988), p.256)
2010-06-02
Remarks on APS by Tirole (1988)
Original article (link) posted: 04/08/2005
Tirole (1988) mentions APS in supplementary section. His description about optimal collusions is very clear, so I will quote it here.
Abreu, Pearce and Stacchetti (1986, 1990) show that one can indeed restrict attention to a collusive phase and a punishment phase, characterized by payoffs V+ and V-, where V+ and V- are now the best and worst elements in the set of symmetric perfect equilibrium payoffs. Furthermore, the collusive phase and the punishment phase take simple forms. In the collusive phase, the firms produce output q+. The punishment phase is triggered by a tail test, i.e., it starts if the market price falls under some threshold level p+. Thus, the collusive phase is qualitatively similar to that presumed in Porter (1983) and Green and Porter (1984). The punishment phase, however, does not have a fixed length; rather, it resembles the collusive phase. The two firms produce (presumably high) output q- each. If the market price exceeds a threshold price p-, the game remains in the punishment phase; if it lies below p-, the game goes back to the collusive phase. Thus, the evolution between the two phases follows a Markovian process. The reader may be surprised by the "inverse tail test" in the punishment phase. The idea is that a harsh punishment requires a high output (higher than is even privately desirable); to ensure that the firms produce a high output, it is specified that in the case of a high price (which signals a low output) the game remains in the punishment phase. (Notice that if one restricted punishments to be of the Cournot type, the optimal length of punishment would be T = "infinity", from the APS result on the harshest possible punishment V-.)
(Tirole (1988), p.265)
Tirole (1988) mentions APS in supplementary section. His description about optimal collusions is very clear, so I will quote it here.
Abreu, Pearce and Stacchetti (1986, 1990) show that one can indeed restrict attention to a collusive phase and a punishment phase, characterized by payoffs V+ and V-, where V+ and V- are now the best and worst elements in the set of symmetric perfect equilibrium payoffs. Furthermore, the collusive phase and the punishment phase take simple forms. In the collusive phase, the firms produce output q+. The punishment phase is triggered by a tail test, i.e., it starts if the market price falls under some threshold level p+. Thus, the collusive phase is qualitatively similar to that presumed in Porter (1983) and Green and Porter (1984). The punishment phase, however, does not have a fixed length; rather, it resembles the collusive phase. The two firms produce (presumably high) output q- each. If the market price exceeds a threshold price p-, the game remains in the punishment phase; if it lies below p-, the game goes back to the collusive phase. Thus, the evolution between the two phases follows a Markovian process. The reader may be surprised by the "inverse tail test" in the punishment phase. The idea is that a harsh punishment requires a high output (higher than is even privately desirable); to ensure that the firms produce a high output, it is specified that in the case of a high price (which signals a low output) the game remains in the punishment phase. (Notice that if one restricted punishments to be of the Cournot type, the optimal length of punishment would be T = "infinity", from the APS result on the harshest possible punishment V-.)
(Tirole (1988), p.265)
2010-05-19
The Green-Porter model and APS(1986)
Original article (link) posted: 03/08/2005
In many economic examples of practical interest, the assumption that players observe one another's past action is inappropriate.
...
Green and Porter (1984) and Porter (1983) were the first papers to study discounted repeated games in which players receive information related only stochastically to others actions.
...
For Economists, one of the most attractive features of the model is that it escapes the prediction of dynamically uniform behavior on the most collusive equilibrium path, thereby offering a possible interpretation of observed phenomena such as price wars.
Porter investigated symmetric equilibria that are optimally collusive among a restricted set of "trigger strategy" profiles. (A price realization of less than "p" triggers a T-period phase of Cournot-Nash behavior, after which cooperation resumes until the Cournot phase gets triggered again.)
...
Porter found that it is often optimal to set T="infinity", that is, revert permanently to the stage game Cournot-Nash equilibrium.
Abreu, Pearce and Stacchetti (1986) dropped the restriction to trigger strategy profiles, and characterized optimal pure strategy summetric equilibria of a class of games that generalize the Green-Porter model. They found that a constrained efficient solution is described by two "acceptance regions" in the signal space and two actions. (In the efficient equilibrium, players choose the strategy1 as long as the value of the signal falls in the region1. Otherwise, they switch to the strategy2, and keep playing that strategy as long as the signal falls in the region2.)
...
Using a larger region and a less severe punishment will generally result in a loss of efficiency because of the region's poorer ability to discriminate between good and bad behavior. Thus, after one period of the best equilibrium, player will be instructed either to begin the worst equilibrium or to restart the best equilibrium.
...
Notice that, in every contingency, players are duplicating the behavior of the first period of one of two equilibria (the best or the worst), so only two quantities are ever produced.
(Pearce (1992), p.150-2)
References
Abreu, Pearce and Stacchetti (1986) "Optimal Cartel Equilibria with Imperfect Monitoring" JET, 39
Green and Porter (1984) "Noncooperative Collusion under Imperfect Price Information" Econometrica, 52
Porter (1983) "Optimal Cartel Trigger Price Strategies" JET, 29
In many economic examples of practical interest, the assumption that players observe one another's past action is inappropriate.
...
Green and Porter (1984) and Porter (1983) were the first papers to study discounted repeated games in which players receive information related only stochastically to others actions.
...
For Economists, one of the most attractive features of the model is that it escapes the prediction of dynamically uniform behavior on the most collusive equilibrium path, thereby offering a possible interpretation of observed phenomena such as price wars.
Porter investigated symmetric equilibria that are optimally collusive among a restricted set of "trigger strategy" profiles. (A price realization of less than "p" triggers a T-period phase of Cournot-Nash behavior, after which cooperation resumes until the Cournot phase gets triggered again.)
...
Porter found that it is often optimal to set T="infinity", that is, revert permanently to the stage game Cournot-Nash equilibrium.
Abreu, Pearce and Stacchetti (1986) dropped the restriction to trigger strategy profiles, and characterized optimal pure strategy summetric equilibria of a class of games that generalize the Green-Porter model. They found that a constrained efficient solution is described by two "acceptance regions" in the signal space and two actions. (In the efficient equilibrium, players choose the strategy1 as long as the value of the signal falls in the region1. Otherwise, they switch to the strategy2, and keep playing that strategy as long as the signal falls in the region2.)
...
Using a larger region and a less severe punishment will generally result in a loss of efficiency because of the region's poorer ability to discriminate between good and bad behavior. Thus, after one period of the best equilibrium, player will be instructed either to begin the worst equilibrium or to restart the best equilibrium.
...
Notice that, in every contingency, players are duplicating the behavior of the first period of one of two equilibria (the best or the worst), so only two quantities are ever produced.
(Pearce (1992), p.150-2)
References
Abreu, Pearce and Stacchetti (1986) "Optimal Cartel Equilibria with Imperfect Monitoring" JET, 39
Green and Porter (1984) "Noncooperative Collusion under Imperfect Price Information" Econometrica, 52
Porter (1983) "Optimal Cartel Trigger Price Strategies" JET, 29
2010-05-17
Remarks on Rotemberg and Saloner (1986)
Original article (link) posted: 02/08/2005
Rotemberg and Saloner (1986) show price war during booms, in the sense that firms charge the monopoly price in the low state of demand whereas they charge below the monopoly price in the high state of demand if the discount factor falls in some region. However, we should notice that this price war does not necessarily imply countercyclical move of prices.
This is not a price war in the usual sense, because the price may actually be higher during booms than during busts; thus, that oligopoly prices move countercyclically is not an implication (but is consistent with) of the Rotemberg-Saloner model.
(Tirole, p.250)
Contrary to the Rotemberg-Saloner model, Green and Porter (1984) show that price wars are triggered by a recession. The latter develops the model that formalizes the issue of secret price cutting, in the setting of "imperfect public monitoring" called nowadays. In their model, price wars during recessions are involuntary, which give the incentive not to deviate when demand is not very low. (Remember, there is no private information and price wars are voluntary in Rotemberg-Saloner model.)
Tirole also mentions the following important point.
When price choices are perfectly observable, it makes sense to resort to extreme punishments because such punishments are never observed on the equilibrium path and therefore are costless to the firms (they are just threats). Under uncertainty, mistakes are unavoidable and maximal punishments (eternal reversion to Bertrand behavior) need not be optimal.
(Tirole, p.252)
References
Green and Porter (1984) "Non-cooperative Collusion Under Imperfect Price Information" Econometrica, 52
Rotemberg and Saloner (1986) "AQ Supergame-Theoretic Model of Business Cycle and Price Wars during Booms" AER, 76
Rotemberg and Saloner (1986) show price war during booms, in the sense that firms charge the monopoly price in the low state of demand whereas they charge below the monopoly price in the high state of demand if the discount factor falls in some region. However, we should notice that this price war does not necessarily imply countercyclical move of prices.
This is not a price war in the usual sense, because the price may actually be higher during booms than during busts; thus, that oligopoly prices move countercyclically is not an implication (but is consistent with) of the Rotemberg-Saloner model.
(Tirole, p.250)
Contrary to the Rotemberg-Saloner model, Green and Porter (1984) show that price wars are triggered by a recession. The latter develops the model that formalizes the issue of secret price cutting, in the setting of "imperfect public monitoring" called nowadays. In their model, price wars during recessions are involuntary, which give the incentive not to deviate when demand is not very low. (Remember, there is no private information and price wars are voluntary in Rotemberg-Saloner model.)
Tirole also mentions the following important point.
When price choices are perfectly observable, it makes sense to resort to extreme punishments because such punishments are never observed on the equilibrium path and therefore are costless to the firms (they are just threats). Under uncertainty, mistakes are unavoidable and maximal punishments (eternal reversion to Bertrand behavior) need not be optimal.
(Tirole, p.252)
References
Green and Porter (1984) "Non-cooperative Collusion Under Imperfect Price Information" Econometrica, 52
Rotemberg and Saloner (1986) "AQ Supergame-Theoretic Model of Business Cycle and Price Wars during Booms" AER, 76
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