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We introduce bilateral risk aversion into the mixed adverse selection - moral hazard model of Laffont and Tirole (1986). The presence of exogenous risk interacts with the adverse selection problem in interesting ways. In particular, we show that it is never optimal to present the firm with a fixed price contract, that the efficient firm typically bears more risk than the inefficient firm, and that an increase in exogenous risk may bring about a decrease in expected cost of the project. As a by-product, we also establish that the famous ‘no-distortion-on-the top’ result in adverse selection models relies on risk neutrality of the agent.

This paper studies a dynamic model of perfectly competitive price posting under demand uncertainty. Firms must produce output in advance. After observing aggregate sales in prior periods, firms post prices for their unsold output. In each period, the demand of a new batch of consumers is randomly activated. Existing customers who have not yet bought and then new customers arrive at the market in random order, observe the posted prices, and either purchase at the lowest available price or delay their purchase decision. We construct a sequential equilibrium in which the output produced and its allocation across consumers is efficient. Thus consumers endogenously sort themselves efficiently, with the highest valuations purchasing first. Transaction prices in each period rise continuously, as firms become more optimistic about demand, followed by a market correction. By the last period, prices are market clearing.

This article considers a market served by a monopolist who sells a durable good that depreciates stochastically over time. We show that there exist three types of stationary equilibria: a Coase Conjecture equilibrium, a monopoly equilibrium, and a reputational equilibrium. When the depreciation rate is low, the Coase Conjecture equilibrium is the unique equilibrium. For intermediate values of the depreciation rate, all three equilibrium types coexist. When the depreciation rate is high, the monopoly equilibrium is the unique equilibrium. Consequently, when selling a good of sufficiently low durability, the monopolist does not lose any of her monopoly power. Furthermore, the steady-state output in the reputational equilibrium falls below the monopoly quantity. Hence, in durable goods markets, welfare losses due to monopoly power may be larger than in markets for perishables.

We characterize the optimal screening mechanism for a monopolist facing consumers with privately known demands, some of whom have limited abilities to misrepresent their preferences. We show that consumers with better abilities to misrepresent information benefit from the presence of consumers who lack such abilities. Whenever the fraction of the latter group is positive, there is no exclusion: the firm supplies a positive quantity of the good to all consumers whose valuations exceed marginal cost of production. Our analysis is motivated by the evidence indicating that some individuals have limited ability to misrepresent themselves and imitate others.

A seller and a buyer bargain over the terms of trade for an object. The seller receives a perfect signal that determines the value of the object to both players, whereas the buyer remains uninformed. We analyze the infinite-horizon bargaining game in which the buyer makes all the offers. When the static incentive constraints permit first-best efficiency, then under some regularity conditions the outcome of the sequential bargaining game becomes arbitrarily efficient as bargaining frictions vanish. When the static incentive constraints preclude first-best efficiency, the limiting bargaining outcome is not second-best efficient and may even perform worse than the outcome from the one-period bargaining game. With frequent buyer offers, the outcome is then characterized by recurring bursts of high probability of agreement, followed by long periods of delay in which the probability of agreement is negligible.

We show that a manufacturer facing uncertain demand and selling through a competitive retail market may wish to support adequate retail inventories by preventing the emergence of discount retailers. In our model, discounters offer low prices made possible by low probability of being saddled with unsold inventories in the event of slack demand. Full-price retailers are compensated for a higher probability of unsold inventories by a higher retail price when they sell. We show that preventing discounting increases the manufacturer's wholesale demand and profits, and we delineate demand conditions under which equilibrium inventory holding and consumer welfare increase.

This paper characterizes the set of Nash equilibria in a price setting duopoly in which firms have limited capacity, and in which unit costs of production up to capacity may differ. Assuming concave revenue and efficient rationing, we show that the case of different unit costs involves a tractable generalization of the methods used to analyze the case of identical costs. However, the supports of the two firms' equilibrium price distributions need no longer be connected and need not coincide. In addition, the supports of the equilibrium price distributions need no longer be continuous in the underlying parameters of the model. As an application of our characterization, we examine the Kreps-Scheinkman model of capacity choice followed by Bertrand-Edgeworth price competition and show that, unlike in the case of identical costs, Cournot equilibrium capacity levels need not arise as subgame-perfect equilibria. The low-cost firm has greater incentive to price its rival out of the market than exists under Cournot behavior.

This paper analyzes a duopolistic price setting game in which firms have loyal consumer segments but cannot distinguish them from price-sensitive consumers. The authors adapt a variant of H. Varian's (1980) simultaneous price setting game to analyze price-leader equilibria. The properties of the price-leader equilibria with an exogenously specified leader motivate the construction of a game of timing in which the firm with the larger segment of loyal consumers becomes an endogenous price leader. This demonstrates that consumer loyalty may play an important role in establishing the existence and identity of a price leader. Copyright 1992 by Blackwell Publishing Ltd.

This paper develops a tractable multisectoral dynamic equilibrium model and provides a fairly complete analysis of the dynamics that may arise along the intertemporal competitive equilibrium path. Despite the fact that the environment displays neither random nor deterministic variability, the model may produce oscillations in aggregate variables such as output. consumption, and investment. We show that these oscillations can be exactly periodic, of any finite period ,I. and even totally aperiodic (chaotic). We characterize the parameter values for which each of these cases occur. but also provide some strong global asymptotic stability results.

This chapter utilizes the results of Deneckere ·& Kovenock (1988, 1989, 1992, 1996) on price setting games with capacity constraints and different unit costs up to capacity to analyze the effects of quotas and tariffs in a model in which a domestic market for a homogeneous product is supplied by a duopoly consisting of a domestic and a foreign firm. A model of the timing of price setting is constructed in which the existence of price leadership, as well as the identity of the leader, depends upon the vector of unit costs and capacities (k1, k2, c1, c2). With firm 1 the foreign firm and firm 2 the domestic firm, the levying of a tariff raises the foreign unit cost of production up to capacity to c1t = c1 + t, while the imposition of a ‘binding’ quota reduces capacity from k1 to k1q (the level of the quota). The effects of quotas and tariffs on the equilibrium in the game of timing are examined starting from an initial vector in which costs are identical, c1 = c2 = c. It is shown that, due to the endogeneity of price leadership, trade restrictions can have surprising effects. In addition to the traditional view that quotas hurt the foreign firm and help the domestic firm, and the results of Harris (1985) and Krishna (1989) that quotas may help both firms, we show that with endogenous timing a quota can make the domestic firm worse of and the foreign firm better off (by altering the identity of the price leader). However, a quota will always (weakly) increase price. In contrast, a tariff always (weakly) hurts the foreign firm and (weakly) helps the domestic firm but may, by affecting the leadership role, lower price. The question of the equivalence of quotas and tariffs is also examined. In contrast to the result of Deneckere & Kovenock (1989) for the simultaneous price setting game, we show that with the endogenous timing of price-setting there are certain initial conditions (k1, k2, c1, c2) for which the prices and quantities generated by a ‘binding’ quota can be duplicated by a tariff (and vice versa). It is possible, however, that a quota that reduces the foreign capacity slightly is equivalent only to a very severe tariff. We conclude by showing how the model allows for simple welfare comparisons in environments in which protection is likely.

We examine the optimal selling strategy of a monopolist facing consumers who have privately known demands, and some of whom have limited abilities to misrepresent their preferences. We derive the optimal mechanism in this environment and characterize its properties. In particular, we show that communication with consumers plays a significant role in the process of screening. Consumers who have better abilities to misrepresent information benefit from the presence of consumers who lack such abilities. Whenever the fraction of the latter group of consumers is positive, there is no exclusion: It is optimal for the firm to supply a positive quantity of the good to all consumers whose valuations exceeds the marginal cost of production. Our analysis reflects the view that the environments where individuals can costlessly and effortlessly manipulate and misrepresent their private information, although standard in economics, represent an extreme point in the spectrum of various possibilities. In fact, available evidence suggests that at least some individuals have limited abilities to misrepresent their true types and imitate others' behavior.

This paper focuses on implementation issues in environments where it may be costly for the players to send certain messages. We develop an approach allowing to characterize the set of implementable outcomes in such environments, and then apply it to derive optimal mechanisms. The key elements of our approach are the absence of any restrictions on the communication structure in a mechanism and the ability of the principal to screen the agents not only on the basis of their preferences over the outcomes, but also on the basis of their communication abilities. A number of interesting implications for the monopoly regulation, signaling and screening is derived. In particular, we show that a monopoly may not want to exclude low-valuation consumers if some consumers in the population are not able to misrepresent their valuations, and why the employers may prefer to screen applicants via multiple rounds of interviews rather than via menus of contracts. Our findings also provide a justification for privacy laws.

A central question in economics is understanding the difficulties that parties have in reaching mutually beneficial agreements. Informational differences provide an appealing explanation for bargaining inefficiencies. This chapter provides an overview of the theoretical and empirical literature on bargaining with incomplete information.The chapter begins with an analysis of bargaining within a mechanism design framework. A modern development is provided of the classic result that, given two parties with independent private valuations, ex post efficiency is attainable if and only if it is common knowledge that gains from trade exist. The classic problems of efficient trade with one-sided incomplete information but interdependent valuations, and of efficiently dissolving a partnership with two-sided incomplete information, are also reviewed using mechanism design.The chapter then proceeds to study bargaining where the parties sequentially exchange offers. Under one-sided incomplete information, it considers sequential bargaining between a seller with a known valuation and a buyer with a private valuation. When there is a “gap” between the seller's valuation and the support of buyer valuations, the seller-offer game has essentially a unique sequential equilibrium. This equilibrium exhibits the following properties: it is stationary, trade occurs in finite time, and the price is favorable to the informed party (the Coase Conjecture). The alternating-offer game exhibits similar properties, when a refinement of sequential equilibrium is applied. However, in the case of “no gap” between the seller's valuation and the support of buyer valuations, the bargaining does not conclude with probability one after any finite number of periods, and it does not follow that sequential equilibria need be stationary. If stationarity is nevertheless assumed, then the results parallel those for the “gap” case. However, if stationarity is not assumed, then instead a folk theorem obtains, so substantial delay is possible and the uninformed party may receive substantial surplus.The chapter also briefly sketches results for sequential bargaining with two-sided incomplete information. Finally, it reviews the empirical evidence on strategic bargaining with private information by focusing on one of the most prominent examples of bargaining: union contract negotiations.

With few exceptions, the literature on the role of capacity as a strategic entry deterrent has assumed Cournot competition in the post-entry game. In contrast, our model is in the spirit of Kreps and Scheinkman (1983): the incumbent and entrant sequentially precommit to capacity levels before competing in price. Interesting deterrence effects arise because firms need time to build, i.e. cannot adjust capacity instantaneously in the post-entry game. Depending on the sizes of the fixed set-up cost, the cost of capacity and the relative costs of production, our model produces a wide spectrum of equilibrium behaviors. Using a "reverse-judo" tactic a cost disadvantaged incumbent may limit his capacity to induce the entrant to respond less aggressively. When the incumbent is equally or more efficient, a stochastic version of Gelman and Salop's (1983) judo equilibrium may arise. Entry accommodation can also result in the Stackelberg outcome, or the equilibria from Dixit's (1980) quantity-setting game. In contrast to much previous work, we find that when entry is deterred the incumbent may hold idle capacity.Our model thus provides a unified framework in which several equilibrium phenomena previously suggested in the literature appear as special cases, while at the same time suggesting some new ones. Furthermore, it generates clear predictions about the circumstances under which these different outcomes are likely to occur.

Suppose that a seller and a buyer have private valuations for a good, and that their respective utilities from a trading mechanism are given by us and ub. (These utilities are determined by the valuation for the good, by whether a trade occurs, and by the price which is paid.) Consider the problem of maximizing E[λus + (1 − λ)ub] for some weight λ in the unit interval. It is shown in this article that, if λ is sufficiently close to zero or one, then the maximum value of this objective function attainable by a static revelation mechanism can be arbitrarily closely approximated by equilibria of the sequential bargaining games in which only a single player makes offers. That is, the welfare bound implied by the revelation principle is virtually attainable in offer/counteroffer bargaining. The main condition needed for this result is a monotone-hazard-rate assumption about the distribution of types. A class of examples is presented in which the result holds for all λ (i.e. the entire ex ante Pareto frontier).

This article reconsiders the durable goods monopoly problem when the monopolist's marginal cost is private information. We show that the Coase Conjecture implies the No Trade Theorem: In any equilibrium in which the lowest-cost seller's initial offer approaches her marginal cost, the aggregate probability of trade must vanish. However, we also construct non-Coasean equilibria which approximate the unique outcome of the rental version of the same model. These (stationary) equilibria are comparatively efficient. The results are equally applicable to the mathematically-equivalent problem of sequential bargaining with two-sided incomplete information where one party makes all the offers. What are the consequences of monopoly in a market for a durable good? Present-day understanding of this question divides into two strands of thought. First, the monopolist may effectively lack any ability to credibly precommit on her future output. Under this scenario, the price will drop almost instantaneously to marginal cost, apparently yielding the efficient outcome normally associated with perfect competition.1 Second, the monopolist may possess an explicit (e.g. leasing the good rather than selling2) or implicit (e.g. the maintenance of reputation3) device enabling her to adhere to an output restriction. Under such circumstances, price will be maintained at a non-competitively high level, suggesting an outcome fraught with all the inefficiency of classical monopoly. The conclusions of the first paragraph rest on analysis of a standard model in which the monopolist's payoff function is taken to be common knowledge. A single firm with known constant marginal cost sells an infinitely-durable good to consumers with a known distribution of valuations for the good.4 The firm has the ability to revise its posted price

This paper analyzes a class of alternating-offer bargaining games with one-sided incomplete information for the case of "no gap." If sequential equilibria are required to satisfy the additional restrictions of stationarity, monotonicity, pure strategies, and no free screening, we establish the Silence Theorem: When the time interval between successive periods is made sufficiently short, the informed party never makes any serious offers in the play of alternating-offer bargaining games. A class of parametric examples suggests that the time interval required to assure silence is not especially brief. As a byproduct of the analysis, we also prove (under the same set of assumptions) a uniform version of the Coase Conjecture: When the time interval between successive periods is made sufficiently short, the initial serious offer by either party in an alternating-offer bargaining game must be less than E times the highest possible buyer valuation, for an entire family of distribution functions.

approach. Our model is especially attractive because it starts from economic primitives: a specification of the set of possible individual preference patterns. It shows how specific properties of the distribution of preferences translate into properties of aggregate demand. This allows us to understand the relationship between the distribution of preferences and the degree to which the market introduces biases in product selection. This paper presents a general model of the demand for differentiated products which has as special cases two of the most popular approaches used to analyse welfare and competition in monopolistically competitive markets: the model of spatial competition on the circle and the model of symmetric aggregate demand. The circle model is attractive because both demand and costs have a definite (and easy to visualize) physical foundation and because it is tractable. Salop (1979) provides an exemplary modem analysis. With this model one can analyze the relationship between the optimal amount of product variety and the amount which a monopolistically competitive market will support. In many plausible cases competition produces too much variety. Such a strong conclusion raises questions of robustness. Almost simultaneously, Spence (1976) and Dixit and Stiglitz (1977) developed an alternative approach to monopolistic competition, based upon the Chamberlinian assumption of symmetry (see also Shubik (1959)). Rather than specifying a distribution of preferences and deriving demand through aggregation (as did Salop and his predecessors), these authors started by specifying a symmetric aggregate benefit function indicating how social welfare depends on the amounts of the various products supplied. Both Spence and Dixit-Stiglitz were able to show that the welfare conclusions from the circle model were not robust: depending on the functional form of the benefit function, equilibrium may entail either excessive or insufficient product variety.1 The assumption of symmetric demand has proven fruitful in the analysis of many economic problems. It is therefore natural to ask what distribution of tastes would give

In this paper, the authors analyze a restricted class of equilibria in the dynamic model of J. P. Benoit and V. Krishna (1987) in which firms choose their scale of operation before engaging in a repeated game of price competition. Benoit and Krishna established that all firms carry excess capacity in all collusive equilibria. As the authors are interested in the relationship between excess capacity and collusion in price, they examine equilibria in which firms tacitly collude in price, but not in investment decisions. Copyright 1990 by Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association.

In the Industrial Organization literature, it is generally felt that mergers hurt consumers; not only because of the increased industrial concentration they effect, but also because collusion becomes more likely. In this paper we show that, at least in one important case, this intuition is misguided. If a tacitly collusive agreement enforced by trigger strategies is not initially sustainable, mergers will tend to reduce the chance that it becomes sustainable in the future. This is so because the threat point implicit in the agreement becomes more favorable for outsiders.

In this article we investigate the incentive to merge when firms that produce differentiated products engage in price competition. We demonstrate that mergers of any size are beneficial and are so increasingly: large mergers yield higher profits than smaller ones. This is in contrast to the result that mergers tend to be disadvantageous in quantity-setting games. This qualitative difference follows from the fact that reaction functions are typically upward sloping in price games but downward sloping in quantity games. Thus, the reaction of outsiders reinforces the initial price increase that results from the merger.

When goods are complements or very close substitutes, more tacit collusion is supported by trigger strategies in price setting supergames than in quantity setting supergames. For moderate or poor substitutes, the situation is reversed. This contrasts with the static situation, where price setting strategies always lead to higher welfare.

We characterize the sequential equilibria of a class of infinite-horizon bargaining games with one-sided incomplete information. When the seller (the uninformed party) makes all the offers, we prove a folk theorem: every incentive compatible, individually rational, direct bargaining mechanism is implementable by sequential equilibria. Introducing buyer counteroffers eliminates outcomes which are unfavorable to that party. As the proportion of buyer offers increases, the set of implementable mechanisms shrinks continuously; when the proportion reaches one, only the single outcome most favorable to the buyer remains. Thus, depending on the offer structure, sequentiality may (or may not) impose restrictions beyond static incentive compatibility.

In this article we investigate the nature of equilibrium in markets in which firms choose the scale of operation before they make pricing decisions. We analyze a duopoly model in which firms choose their capacities before engaging in Bertrand-like price competition. We demonstrate that the Cournot outcome is unlikely to emerge in such markets and that the equilibrium tends to be more competitive than the Cournot model would predict. In addition, our results indicate a tendency toward asymmetric firm sizes and price dispersion that results from the mixed strategies firms use in equilibrium.

This paper analyzes durable goods monopoly in an infinite-horizon, discrete-time game. We prove that, as the time interval between successive offers approaches zero, all seller payoffs between zero and static monopoly profits are supported by subgame perfect equilibria. This reverses a well-known conjecture of Coase. Alternatively, one can interpret the model as a sequential bargaining game with one-sided incomplete information in which an uninformed seller makes all the offers. Our folk theorem for seller payoffs equally applies to the set of sequential equilibria of this bargaining game.

It has been argued that two factors-product durability and (potential) entry-may force a monopolist to price at marginal cost. This article shows that when these two forces coexist, the tendency toward competition may be negated. First, we prove that durable goods oligopolists without commitment powers may attain joint profits arbitrarily close to those of a monopolist with perfect commitment power. Second, we demonstrate that the presence of a potential entrant may enable a durable goods monopolist to act as if he had commitment power. Thus, potential as well as actual entry may restore monopoly power.