Advances in Applied Microeconomics: Volume 8

We consider a model of quality competition among health care providers and demonstrate that the equilibrium in the market is characterized by strict differentiation in the quality of care that is offered to consumers. The market outcome generates excessive investment in quality in comparison to the socially optimal outcome and, as a result, an excessive number of low income individuals who find health care unaffordable. The extent of deviation from universal coverage is more severe the lower the co-insurance rates paid by individuals.

In this chapter we model localized competition between firms when consumers exhibit brand lock-in or loyalty. We derive the symmetric equilibrium mixed strategy price distribution under two alternative models, and compare them to symmetric equilibrium strategies under non-localized competition. Contrary to the conventional wisdom in the product differentiation literature, the expected posted prices of firms are lower with localized competition. The analysis questions the robustness of models of product differentiation which ignore consumer lock-in.

Posted offer markets with costly buyer search are investigated in 18 laboratory sessions. Each period sellers simultaneously post prices. Then each buyer costlessly observes one or two of the posted prices and either accepts an observed price, drops out, or pays a cost to search again that period. The sessions vary the number of observed prices (one or two), the search cost, and the number and kind of buyers. When there are more buyers (especially robot buyers), observed transaction prices conform remarkably closely to theory (competitive Bertrand prices when buyers observe two prices and monopoly Diamond prices when buyers observe only one price). With human subject buyers we observe less extreme prices, but outcomes are closer to theory than outcomes in previous laboratory experiments with similar environments.

This chapter analyzes the owner-manager contracting problem for firms competing in imperfectly competitive markets. The strategic interdependence of firms results in optimal incentive contracts that either compensate or penalize managers for sales. The predictions of the model are tested empirically and estimates of contract coefficients are reported. The results fail to confirm the predictions of the theoretical model; however, the coefficient estimates suggest that while the effects of profits and sales on compensation vary significantly across firms and industries, managers of most firms are rewarded for increases in firm profits.

Given the widespread adoption of low-price guarantees and discussion of their anti-competitive effects in the theoretical literature, it is unfortunate that there is little empirical evidence available on the subject. This chapter analyzes the effects of low-price guarantees on advertised tire prices, based on P185/75R14 retail tire prices collected from U.S. Sunday newspapers. We find that although a tire retailer's own price-matching or price-beating guarantee has no significant effect on the retailer's advertised tire price, an increase in the percentage of firms in the market announcing low-price guarantees tends to raise the firm's advertised tire price. In particular, we find that the predicted tire prices are approximately $4 higher (about 10 percent of the average advertised price of a P185/75R14 tire) in markets in which all firms advertise an LPG when compared to markets without any LPGs.

We find equilibrium price distributions in a search model with asymmetric duopolists whose marginal costs differ. There are informed consumers who know both prices and buy at the lower one and uninformed consumers who, not knowing prices, choose a store arbitrarily. With asymmetries, pure strategy equilibrium can exist and, even when not, atoms can exist in the firms' price distributions. One surprising result is that increasing the low cost store's marginal cost can lower average prices and raise the expected utilities of both types of consumers. When the low cost firm is foreign, this could justify imposing a tariff.

The welfare and political support effects arising from the actual or potential imposition of a quota are examined. There exists an obvious inherent conflict between domestic producers and domestic consumers. Increased imports cause a downward pressure on domestic prices and, hence, improve domestic consumer welfare while diluting domestic producer profits. This chapter specifically investigates how benevolent or self-interested policymakers respond to increased foreign competition in an oligopolistic market, that is, how they resolve the trade-off between domestic producer and consumer surplus as the number of foreign firms grows.

While some countries coordinate their tax policies for multinationals with their commercial trade policies, the practice is not universal. Many countries, including the United States, formulate tax policies solely to mitigate tax avoidance practices like strategic transfer pricing. In this chapter, I consider an environment in which a host country has incomplete information about a multinational's foreign operations. I show that a policy that seeks to achieve arm's-length transfer prices is consistent with broader welfare objectives when the multinational's home country adopts a commensurate-with-income standard (ruling out repatriated losses) and when the multinational prefers pre-tax operating profit over post-tax transfer price profit. This result is based on a previously unidentified externality created by the opportunity for multinationals to engage in strategic transfer pricing.

This chapter examines the linkage between the product market structure and the financial structure of firms in a two-stage Coumot-Nash oligopoly. The firms raise debts in the first stage and then compete in output markets in the second stage. We analyze the effect of the number of firms on their financial structure. It is found that the upper limit to the debts of the firms decreases with the number of firms. That is, the more concentrated the product markets, the more debts the firms can raise. The model is tested empirically using data taken from Korean firms. Empirical test results are found to be weakly in accordance with theoretical predictions.

Salop and Stiglitz analyzed an equilibrium search model under a Stackelberg assumption that consumers could react to changes in the distribution of prices charged by firms even though they did not know which particular firms were charging the lowest price. In this chapter we assume that firms and consumers move simultaneously so that consumers cannot react to changes in the price distribution. We also assume that a firm cannot limit sales if demand exceeds its desired supply at the price it sets. In contrast to Salop and Stiglitz, a single-price equilibrium at the monopoly price always exists. For most distributions of consumer search costs, a range of two-price equilibria will also exist. In the two-price equilibria, the high price is always the monopoly price while the low price varies in a range above the minimum of average total cost.

This chapter examines the optimal choice of managerial incentives for firm owners in a multi-stage oligopoly. In our three-stage owner-manager game, characterized by pre-product launch investments such as advertising, the owners never tell their managers to maximize profits. The contract to maximize profits is not a self-representational Nash Equilibrium. When advertising is a strategic substitute, the owners induce their managers to advertise more aggressively than is necessary for profit maximization, even if they only care about profits. When advertising is a strategic complement, however, the strategic effects are reversed.