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Abstracts of 2001 Working Papers

WORKING PAPER NO 623
A Note on Two Notions of Arbitrage
Nizar Allouch
Since Hart's [5] and Werner's [10] seminal papers, several conditions have been proposed to show the existence of equilibrium in an asset exchange economy with short-selling. In this note, we discuss the relationship between two no-arbitrage conditions. The first condition is the assumption that the individually rational utility set U is compact, as considered by Dana, Le Van and Magnien [1]. The second is inconsequential arbitrage, introduced by Page, Wooders and Monteiro [9]. The main result of this comparison is to show that the inconsequential arbitrage condition is stronger than the assumption that U is compact.
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WORKING PAPER NO 622
Tax Competition Reconsidered
Myrna H Wooders, Ben Zissimos and Amrita Dhillon
In a classic model of tax competition, we show that the level of public good provision and taxation in a Nash equilibrium can be efficient or inefficient with either too much, or too little public good provision. The key is whether there exists a unilateral incentive to deviate from the efficient
state and, if so, whether this entails raising or lowering taxes. A priori, there is no reason to suppose the incentive is in either one direction or the other. In addition, we demonstrate conditions ensuring existence of an asymmetric Nash equilibrium with efficient public good provision. As in prior literature, local amenities enhance capital’s productivity. Prior literature, however, focuses on under-provision of public goods.
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WORKING PAPER NO 621
Networks and Farsighted Stability
Frank H PageJr, Myrna H. Wooders and Samir Kamat
The main contribution of this paper is to provide a framework in which the notion of farsighed stability for games, introduced by Chwe (1994) can be applied to directed networks. Then, using Chwe's basic result on the nonemptiness of farsightedly stable sets for games, we show that for any given collection of directed networks and any given collection of rules governing network formation, there exists a farsightedly stable directed network.
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WORKING PAPER NO 620
Female Competition, Evolution and the Battle of the Sexes
Myrna Wooders and Hugo van den Berg
As female primates carry and nurse the fetus, it naturally falls on them to rear the offspring. On the assumption that males are at least equally adept at obtaining food, it follows that they generate a surplus which they might either share with females or consume themselves. This choice lies at the heart of an evolutionary battle of the sexes. If females suceed in obtaining a large share of the surplus, there is little scope for size dimorphism between males and females; otherwise males can use the surplus to sustain larger and stronger bodies, which are advantageous in sexual competition with other males. Besides competing with males, females may compete with each other. Moreover, dependency may coincide with sexiness and such dependency can persist. This paper examines these ideas in a game-theoretic setting.
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WORKING PAPER NO 619
Can Indonesia Gain from Log Export Barriers?
May Arunanondchai
We use a simple model of sequential duopoly to examine the effect of different industrial structures on firms' output decision and profit shares in the international market for raw and processed tropical timber products. The model provides insights that can be applied to the Indonesian logging and plywood industry: shedding light on the appropriate policy responses.

Whether optimal trade policy in each industry involves a tax or subsidy depends on the ownership structure and on the comparative profit margins from upstream and downstream exports. Log barriers may improve welfare even if the downstream sector is inefficient. When the industry is vertically separated, this is true regardless of the comparative profit margins. However, when the industry is vertically integrated (which is the case of Indonesia), this is only true when the downstream sector is more profitable at the margin.
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WORKING PAPER NO 618
Factors Affecting the Probability of First-year Medical Student Dropout in the UK: A logistic analysis for the entry cohorts of 1980-1992
Wiji Arulampalam, Robin Naylor and Jeremy Smith

Objectives: To assess the extent to which various factors influence the probability that an individual medical student will drop out of medical school during their first year of study, focussing on the influence both of prior qualifications, such as A-level subjects taken and scores attained, and of type of school and family background.

Results: The probability that a student will drop out of medical school during their first year of study is influenced significantly both by the subjects studied at A-level and by the scores achieved. Among students who took Biology, Chemistry and Physics at A-level, each extra grade achieved reduces the probability of dropping out by about one-third of a percentage point. There is an additional effect for students with the maximum A-level score of 30 points in their best 3 A-levels (that is, three grade As): such a student is almost one percentage point less likely to drop out of medical school, ceteris paribus, compared to a student with 28 points. Furthermore, this estimated effect of A-level performance on dropout behaviour is very similar for each of the 13 cohorts. In general, indicators of both the social class and the previous school background of the student are largely insignificant, with the exception that students with a parent who is a medical doctor are significantly less likely to drop out. There are significant differences by gender, with males more likely to drop out. There is also evidence of significant age effects, with a tendency for the dropout probability to fall with age.
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WORKING PAPER NO 617
What has been Happening to the Quality of Workers' Lives in Britain
Jonathan Gardner and Andrew J. Oswald

This paper studies workers’ lives in modern Britain. It uses longitudinal data to examine stress and job satisfaction through the decade of the 1990s. The results are disturbing. On both measures, the wellbeing of British public sector workers worsened sharply over the decade. The size of the deterioration was between one half point and one full point on a standard GHQ mental stress scale. This is remarkably large. Stress levels among private sector employees also rose. Job satisfaction in the private sector ran approximately flat through time. These findings may be of interest to nations who are thinking of adopting the British government’s policies towards the public sector, and to those who have conjectured that working life is becoming more pressurised.
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WORKING PAPER NO 616
Well-Being over Time in Britain and the USA
David G. Blanchflower and Andrew J Oswald

This paper estimates micro-econometric happiness equations for the United States and Great Britain. Reported levels of wellbeing have declined over the last quarter of a century in the US; life satisfaction has run approximately flat through time in Britain. These findings are consistent with the Easterlin hypothesis (1974, 1995). The happiness of American blacks, however, has risen. Despite legislation on gender discrimination, the well-being of women has declined. White women in the US have been the biggest losers. Well-being equations have a stable structure. Money buys happiness. People care also about relative income. Wellbeing is U-shaped in age. The paper estimates the dollar values of events like unemployment and divorce. They are large. A lasting marriage (compared to widow-hood as a ‘natural’ experiment), for example, is estimated to be worth $100,000 a year.
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WORKING PAPER NO 615
The Macroeconomics of Happiness
Rafael di Tella, Robert J. MacCulloch and Andrew J Oswald

This paper shows that macroeconomic movements have strong effects on the happiness of nations. First, we find that there are clear microeconomic patterns in the psychological well-being levels of a quarter of a million randomly sampled Europeans and Americans from the 1970's to the 1990's. Happiness equations are monotonically increasing in income, and have a similar structure in different countries. Second, movements in reported well-being are correlated with changes in macroeconomic variables such as Gross Domestic Product. This holds true after controlling for the personal characteristics of respondents, country fixed-effects, year dummies, and country-specific time trends. Third, the paper establishes that recessions create psychic losses that extend beyond the fall in GDP and rise in the number of people unemployed. These losses are large. Fourth, the welfare state appears to be a compensating force: higher unemployment benefits are associated with higher national well-being.
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WORKING PAPER NO 614
Demand for Money in the Transition Economy: The Case of the Czech Republic 1993-2001
Lubos Komarek and Martin Melecky
In this paper we strive to present a somewhat internationalised view of demand for money as applied to the Czech Republic. We extend the traditional money demand function, consisting purely of domestic variables, to include certain foreign determinants that probably affect the demand for money in a small open transition economy. We do so in the case of both narrow and broad money. For the purposes of generalisation and robust estimates we employ several estimation techniques, namely the Johansen procedure, ARDL, DOLS and ADL. We also consider the aspect of the stability of such estimates. Finally, we analyse the possible effects on prices and output of disequilibria on money market. We have found that a
liquidity gap probably has a significant influence on both prices and output.
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WORKING PAPER NO 613
Currency Substituion in the Transition Economy: A Case of the Czech Republic 1993-2001
Lubos Komarek and Martin Melecky
Currency substitution appears to be an important issue affecting the design of monetary policy, especially in transition economies. Therefore, this paper strives to analyze the particular relevance of a currency substitution phenomenon for the Czech Republic is case. We initially discuss various approaches and definitions of currency substitution that found in the literature. Subsequently, we discuss the role of currency substitution in small open economies in transition with some illustrations relating to the Czech Republic - we distinguish and analyse a locally and globally substituting currency from a substituted one and consequences of euroization. The empirical part of this paper presents estimations of modified Branson and Henderson portfolio model for the Czech Republic’s
case. This provides a multi-perspective approach to currency substitution in a broad sense. Further, we attempt to intensify the robustness of our estimation, applying several cointegration techniques. These are namely the Johansen procedure, the ARDL, the DOLS and the ADL. Finally, we discuss potential implications of currency and assets substitution according to our estimates present in the Czech economy.
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WORKING PAPER NO 612
Profit-Sharing, Bertrand Competition and Monopoly Unions: A Note
Amrita Dhillon and Emmanuel Petrakis
This paper studies a strategic aspect of profit-sharing in an oligopolistic industry with a monopoly union. Whenever a uniform profit share exists in the industry, we show that a union that values the per worker remuneration positively, may have incentives to reduce industry employment, decreasing thus total output and causing total profits to increase. Thus, we show that profit-sharing may lead to higher profits for such an industry even if productivity effects are absent.
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WORKING PAPER NO 611
The Political Economy of a Soviet Military R&D Failure: Steam Power for Aviation, 1932 to 1939
Mark Harrison

By studying a Soviet R&D failure, the prewar attempt to create a new aeroengine technology based on the steam turbine, we find out more about the motivations, strategies, and payoffs of principals and agents in the Soviet command economy. Alternative approaches to the evaluation of R&D failure are outlined. New archival documentation shows the scale and scope of the Soviet R&D effort in this field. The allocation of R&D resources resulted from agents’ horizontal interactions within a vertical command hierarchy. Project funding was determined in a context of biased information, adverse selection, and agents’ rent seeking. Funding was rationed across projects and through time. Budget constraints on individual projects were softened in the presence of sunk costs, but were hardened periodically. There is no evidence that rents were intentionally distributed through the Soviet military R&D system to win trust or reward loyalty; the termination of aviation steam power R&D in 1939 despite
the sunk costs they represented was timely.
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WORKING PAPER NO 610
The Battle of the Sexes over the Distribution of Male Surplus
Myrna Wooders and Hugo van den Berg

Female primates carry and nurse the fetus, and thus have the firrst
responsibility for rearing the offspring. Assuming males are at least equally
adept at obtaining food, males might either share surplus food with females or consume the food themselves. The distribution of the surplus is the subject of a battle of the sexes. If females succeed in obtaining a large
share of the surplus, then there is little size dimorphism between males and females; otherwise males use the surplus themselves to become larger and stronger, and to engage in sexual competition with other males. Besides competing with males, females may compete with each other. Dependency may coincide with sexual competitiveness (sexiness). This paper introduces these ideas in a game theoretic setting and derives a simple bound on the male ‘sexiness’ required for a nonsupportive strategy to be worthwhile.
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WORKING PAPER NO 609
Soviet Industry and the Red Army Under Stalin: A Military-Industrial Complex?
Mark Harrison
The paper considers some of the views of the Stalin–era relationship between Soviet industry and the Red Army that are current in the literature, and disentangles some confusions of translation. The economic weight of the defence sector in the economic system is summarised in various aspects. The lessons of recent archival research are used as a basis for analysing the army–industry relationship under Stalin as a
prisoners’ dilemma in which, despite the potential gains from mutual cooperation, each party faced a strong incentive to cheat on the other. It is concluded that the idea of a Soviet military–industrial complex is not strictly applicable to the Stalin period, but there may be greater justification for the Soviet Union after Stalin.
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WORKING PAPER NO 608
Learning in elections and Voter Turnout Equilibria
Stefano DeMichelis and Amrita Dhillon
Both complete and incomplete game Theoretic Models of Voter Turnout
(Palfrey and Rosenthal, 1983,1985) have the problem of multiple equilib-
ria, some of which seem unreasonable. How can the counter intuitive high
turnout equilibria be explained? Palfrey and Rosenthal (1985) suggest
that the main reason is that strategic uncertainty istoo low in a com-
plete information model. We show that this is not the main problem with
these equilibria{ incomplete information may exacerbate the problem of
multiple equilibria. We propose a very intuitive criterion based on voter
learning to distinguish reasonable equilibria. This paper makes precise the
sense in which the high turnout equilibria in the Palfrey-Rosenthal model
are not robust. We show how the model can be used to qualitatively
explain several phenomena observed in reality.
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WORKING PAPER NO 607
The Role of Consumers in Competition and Competion Policy
Michael Waterson
This paper develops the idea that consumers’ behaviour matters significantly from the viewpoint of industry performance. This is examined through some theoretical propositions, but then at greater length by means of some case study examples. These examples demonstrate how, even in potentially competitive industries, reluctance on the part of consumers to search or to switch suppliers can lead to a sub-competitive outcome. The significance of non-traditional competition policy remedies in changing the outcome is drawn out.
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WORKING PAPER NO 606
Plan, Siphoning, and Corruption in the Soviet Command Economy
Mark Harrison and Byung-Yeon Kim
This paper reconsiders Andrei Shleifer and Robert Vishny’s suggestion that a socialist industry will always prefer to cut both price and output relative to a market–clearing equilibrium in order to maximise bribe income. The evidence from recent archival studies of the Soviet economy does not support this conjecture. To understand the evidence we present an analytical framework within which a plan–setter and an effort–setter interact, subject to a hard resource constraint, to determine real output and hidden inflation simultaneously. We find that managers who use
resources gained corruptly were enabled to produce more real output with less hidden inflation and fulfil the plan more honestly as a result. We find clear rationales for plan–setters to have tolerated corruption and siphoning while maintaining plan tension, and we associate reduced plan tension in the 1970s with the spread of disloyal behaviours.
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WORKING PAPER NO 605
The Soviet Market for Inventions:
The Case of Jet propulsion 1932 to 1944
Mark Harrison
The paper outlines the problem of aviation jet propulsion in the interwar period and World War II and analyses Soviet progress towards a solution using newly available archival documentation. Soviet R&D commitments were influenced by long–term security motivations and the need to invest in local tacit knowledge. The scale and diversity of the Soviet R&D effort is described. The allocation of resources resulted from R&D agents’ horizontally organised market–like interactions within a vertically organised command system. Financing decisions were made in a context of asymmetric information, adverse selection, and opportunism. Overall funding was rationed; budget constraints on individual projects were soft, but were periodically hardened. In addition to decisions to finance and refinance or terminate projects, takeovers and mergers took place in a secondary asset market. There is evidence of rent–seeking activity, but where rent–seeking was detected it was punished.
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WORKING PAPER NO 604
Are Command Economies Unstable? Why did the Soviet Economy Collapse?
Mark Harrison
The collapse of the Soviet economy at the end of the 1980s is ascribed to command failure. The likely sources of command failure and economic collapse in the Soviet case are analysed in terms of the payoffs to a dictator who controls the level of coercion and producers who control the level of effort. This approach is used to frame an analytical narrative of the evolution of the Soviet system under Brezhnev and Gorbachev. The paper is a nontechnical version of TWERPS no. 602.
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WORKING PAPER NO 603
The USSR and Total War: Why didn't the Soviet Economy Collapse in 1942
Mark Harrison
The economic dimensions of the Soviet war effort are appraised. The surprising fact is that the Soviet economy did not collapse in 1942. A rational-choice model is developed to illustrate the economic conditions under which a wartime collapse of the economy is rendered more and less likely.
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WORKING PAPER NO 602
Coercion, Compliance and the Collapse of the Soviet Economy
Mark Harrison
Are command systems that rest on coercion inherently unstable, and did the Soviet economy collapse for this reason? Postwar evidence is inconsistent with the hypothesis that the Soviet economy was unstable. If it was not unstable, why did it collapse? A repeated game of coordination between a dictator and producers shows that a high level of coercion may yield a stable high–output equilibrium, that the command economy contains a time–consistency problem for central planners, and that a transition to a low state of coercion and performance in which everyone’s income falls may be brought about by rising monitoring costs and the dictator’s loss of reputation. The facts of the Soviet case are consistent with a collapse triggered when the dictator threw in the towel.
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WORKING PAPER NO 601
Evolution &Voting: How Nature Makes us Public Spirited
John P. Conley, Ali Toossi and Myrna Wooders
We reconsider the classic puzzle of why election turnouts are persistently
so high when formal analysis strongly suggests that rational agents
should not vote. If we assume that voters are not making systematic mistakes,the most plausible explanation seems to be agents receive benefits, from the act of voting itself. This is very close to assuming the answer, however, and immediately begs the question of why agents feel a warm glow from participating in the electoral process. In this paper, we approach this question from an evolutionary standpoint. We show for a
range of situations that public-spirited agents have an evolutionary ad-
vantage ver those who are not as public-spirited. We also explore when
this kind of altruistic behavior is disadvantageous to agents. The details
depend on the costs of voting, the degree to which agents have different
preferences ver public policies and the ratio of various preference types in
the population, but we conclude that evolution may often be a force that
causes agents to internalize the benefits their actions confer on others
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WORKING PAPER NO 600
Government Collusion in Janeba's Model of Multijurisdictional Tax Competition
Lloyd Barton
Eckhard Janeba (Dec 2000 “Tax Competition when Governments lack Commitment” American Economic Review 90, 1508-19) has recently suggested a novel approach to modelling the relationship between governments and multinational firms. As part of ongoing research into various aspects of multijurisdictional tax competition, this paper investigates the possibility of allowing for collusion between governments when setting tax rates in the model. The findings show that a self-enforcing agreement is possible, with the beneficial effect of cutting the firm’s excess profits, limiting investment in excess capacity, and raising government revenue.
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WORKING PAPER NO 599
My Word is My Bond: Reputation as Collateral in Nineteenth Century English Provincial Banking
Francesco L. Galassi and Lucy A. Newton

There are few real-world economic transactions that do not involve an element of trust, yet in textbook economics trust is not prominently discussed. In that world, perfectly informed and computationally endowed agents reach optimal, enforceable decisions in continuously harmonising exchanges. Trust is therefore linked to deviations from the textbook ideal: incomplete information, costly enforcement, and computational limitations faced by agents. Trust can then be thought of as an algorithm, in other words, a way of resolving uncertainty in a complex world. In this sense trust may be seen as a form of expectation concerning the behaviour of other agents whose actions and intentions cannot be (fully) observed. This paper pursues this approach by “running the algorithm backwards” and trying to establish what factors led a 19th century provincial English bank to trust different loan applicants. Using a data-set of some 200 loan decisions, and knowing the size of collateral (if any) requested, we develop a method to estimate the probability that the bank attached to each borrower’s promise to repay (i.e., the trust the bank had towards the borrower), adjusting for stages in the business cycle. We then regress this estimated probability on a variety of observable borrower characteristics. We find that trust is not correlated with a priori expected variables, such as borrower’s assets or frequency of interaction. This suggests that trust was built up in other interactions, possibly through social or religious networks, and that the banking relationship reflected information available to bank directors other than what was purely pertinent to the borrowers’ economic conditions. This has strong implications for the allocation of credit to industry in 19th century England.
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WORKING PAPER NO 598
The Geometry of Arbitrage and the Existence of Competitive Equilibrium
Nizar Allouch, Cuong le Van and Frank H. Page Jr

We present the basic geometry of arbitrage, and use this basic geometry to shed new light on the relationships between various no-arbitrage conditions found in the literature. For example, under very mild conditions, we show that the no-arbitrage conditions of Hart (1974) and Werner (1987) are equivalent and imply the compactness of the set of utility possibilities. Moreover, we show that if agents' sets of useless net trades are linerly independent, then the Hart-Werner conditions are equivalent to the stronger conditon of no-unbounded-arbitrage due to Page (1987) - and in turn, all are equivalent to compactness of the set of rational allocations. We also consider the problem of existence of equilibrium. We show, for example that under a uniformity condition on preferneces weaker than Werner's Uniformity condition, the Hart-Werner no-arbitrage conditions are sufficient for existence. With an additional condition of weak no half-lines - a condition weaker than Werner's no-half-lines condition - we show that the Hart-Werner conditions are both necessary and sufficient for existence.
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WORKING PAPER NO 597
A Hazard Model of the Probability of Medical School Dropout in the United Kingdom
Wiji Arulampalam, Robin A. Naylor and Jeremy P. Smith

From individual-level longitudinal data for two entire cohorts of medical students in UK universities, we analyse the probability that an individual student will ‘drop out’ of medical school prior to the successful completion of their studies. We examine the cohort of students enrolling for a medical degree at the start of the academic years 1985 or 1986. We find evidence that medical student completion is influenced by measures of academic preparedness, sex, and age as well as by the characteristics of the medical school itself. On the basis of our results, we also comment on the construction of institutional performance indicators against the criterion of student dropout.
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WORKING PAPER NO 596
Real Exchange Rate Trends in Transitional Countries
Jan Frait and Lubos Komarek

The paper presents an analysis of the determinants of the real exchange rate with emphasis on its long-term aspects and searching for the equilibrium paths. It introduces the behavioural models of exchange rates (especially the BEER and the NATREX), that are alternatives to the often-used fundamental models of the FEER type. Authors constructed the theoretical and econometric behavioural model, which could analyse the medium-term and long-term dynamics of the real exchange rate. This paper also introduces real exchange rate as an indicator of convergence for transitional countries to EU countries and analyses the link between real exchange rate and double speed economy or deindustrialisation, respectively. This analysis is relevant almost for all transitional countries now. The paper explains the appreciation trend of real exchange rates in transitional economies. It is identifying the set of factors that let to sustainable real appreciation of the Czech Koruna and also the set of factors that possibly caused unsustainable real depreciation in the past. There is also a set of arguments against any other rapid real appreciation of the Czech Koruna. The paper also tried to fuel these arguments by an econometric analysis, which used our behavioural model of the equilibrium real exchange rate. It was shown that the Czech real exchange rate was especially determined by real fundamental factors: productivity, terms of trade and world interest rates and foreign direct investment.
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WORKING PAPER NO 595
Construction of Stationary Time Series via the Giggs Sampler with Application to Volatility Models
Michael K Pitt and Stephen G Walker

In this paper, we provide a method for modelling stationary time series. We allow the family of marginal densities for the observations to be specified. Our approach is to construct the model with a specified marginal family and build the dependence structure around it. We show that the resulting time series is linear with a simple autocorrelation structure. In particular, we present an original application of the Gibbs sampler. We illustrate our approach by fitting a model to time series count data with a marginal Poisson-gamma density.
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WORKING PAPER NO 594
Multiproduct Firms and Product Differentiation: a survey
Juan A. Manez and Michael Waterson

We start the survey by reviewing the implications of horizontal and vertical product differentiation on market structure under the assumption of single-product firms. Then, we analyse the main results of the multi-product firm models, both when variants are assumed differentiated in vertical attributes only and when varieants are assumed differentiated in two dimensions (vertical and horizontal). Finally, we review the empirical literature about the discrete-choice models of product differention.
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WORKING PAPER NO 593
Market Structure and Entry: Where's the Beef?
Otto Toivanen and Michael Waterson

We study the effects of market structure on entry using data from the UK fast food (counter-service burger)industry over the years 1991-1995. Over this period, the market can be characterized as a duopoly. We find that market structure matters greatly: for both firms, rival presence increases the probability of entry. We control for market specific time-invariant unobservables and their correlation with existing outlets of both firms through a variety of methods. Such unobservables generally play a minor role. For both firms, variable profits per customer are increasing in the number of own outlets, and decreasing in the number of rival outlets. Structural form estimations show that the positive effect of rival presence on the probability of entry is due to firm learning: rival presence increases the estimate of the size of the market. The firms are differently affected by demand variables and have different fixed costs of entry. These results strongly suggest the presence of product differentiation, firm learning and market power.
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WORKING PAPER NO 592
Three Principles of Competitive Nonlinear Pricing
Frank H. Page Jr and Paulo K. Monteiro

We make three contributions to the theory of contracting under asymmetric information. First , we establish a competitive analog to the revelation principle which we call the implementation principle. This principle provides a complete characterization of all incentive compatible, indirect contracting mechanisms in terms of contract catalogs (or menus), and allows us to conclude that in competitive contracting situations, firms in choosing their contracting strategies can restrict attention, without loss of generality, to contract catalogs. Second, we establish a competitive taxation principle. This principle, a refinement of the implementation principle, provides a complete characterization of all implementable nonlinear pricing schedules in terms of product-price catalogs and allows us to reduce any game played over nonlinear pricing schedules to a strategically equivalent game played over product-price catalogs. Third, applying the notion of payoff security (Reny (1999)) and the competitive taxation principle, we demonstrate the existence of a Nash equilibrium for the mixed extension of the nonlinear pricing game. Moreover, we identify a large class of competitive nonlinear pricing games whose mixed extensions satisfy payoff security.
This paper extends earlier work by the first author (see Page 1992, 1999)).

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WORKING PAPER NO 591
Bayesian Cointegration Analysis
Katsuhiro Sugita

This paper proposes Bayesian estimation of cointegrated VAR systems and a simple method of estimating the cointegration rank using the Bayes factors for the adjustment term. Monte Carlo experiments show that the method proposed is more powerful in selecting the rank, especially with a small sample size, than Johansen's LR test. This is due to the fact that Bayesian analysis uses the exact distributions instead of relying on asymptotic distribution theory. The method proposed here is relatively easy to implement. Over-identifying restrictions on the cointegrating vectors are also considered.
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WORKING PAPER NO 590
Leadership Cartels in Industries with Differentiated Products
Pedro Posada

This article analyses cartels that act as a Stackelberg leader with respect to a competitive fringe in industries supplying differentiated products. The main objectives are to investigate how cartel stability changes with the degree of differentiation and the cartel size, to predict endogenous cartels and to carry out a welfare analysis. Both repeated and static games are considered as well as industries competing in quantities and prices. The results indicate that the degree of stability can be either an increasing, decreasing or non-monotonic function of the degree of product differentiation, depending on the cartel size, the industry size, the competition type and the reaction of cartel loyal members to defection. An endogenous cartel size is also predicted. Other significant results are: some cartels can be sustained under simple static game Nash equilibrium, some cartels may be socially desirable, not all cartels are beneficial for the fringe members and a free riding problem does not necessarily emerge
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WORKING PAPER NO 589
Some First Results for Noncooperative Pregames:
Social Conformity and Equilibrium in Pure Strategies
Myrna Wooders, Reinhard Selten and Edward Cartwright

We introduce the framework of noncooperative pregames and
demonstrate that for all games with sufficiently many players, there exist approximate (E) Nash equilibria in pure strategies. In fact, every mixed strategy equilibrium can be used to construct an E-equilibrium in pure strategies — ours is an 'E-purification’ result. Our main result is that there exists an E-equilibrium in pure strategies with the property that most players choose the same strategies as all other players with similar attributes. More precisely, there is an integer L, depending on E but not on the number of players, so that any sufficiently large society can be partitioned into fewer than L groups, or cultures, consisting of similar players, and all players in the same group play the same pure strategy. In ongoing research, we are extending the model to cover a broader class of situations, including incomplete information.

We would be grateful for any comments that might help us improve the
paper.
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WORKING PAPER NO 588
Arbitrage and Equilibrium in Economies with Externalities
Cuong Le Van, Frank H. Page Jr. and Myrna H Wooders

We introduce consumption externalities into a general equilibrium model with arbitrary consumption sets. To treat the problem of existence of equilibrium, a condition of no unbounded arbitrage, extending the condition of Page (1987) and Page and Wooders (1993, 1996) is defined. It is proven that this condition is sufficient for the existence of an equilibrium and both necessary and sufficient for compactness of the set of rational allocations.
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WORKING PAPER NO 587
Fair Reweighting of the Votes in the EU Council of Ministers and the Choice of Majority Requirement for Qualified Majority Voting during Successive Enlargements
Dennis Leech

This paper examines the system of Qualified Majority Voting, used by the Council of Ministers of the European Union, from the perspective of enlargement of the Union. It uses an approach based on power indices due to Penrose, Banzhaf and Coleman to make two analyses: (1) the question of the voting power of member countries from the point of view of fairness, and (2) the question of how the majority quota required for QMV should be determined. It studies two scenarios for change from 2005 onwards envisaged by the Nice Treaty: (1) no enlargement, the EU comprising 15 member countries, and (2) full enlargement to 27 members by the accession of all the present twelve candidates. The proposal is made that fair weights be determined algorithmically as a technical or routine matter as the membership changes. The analysis of how the quota affects power shows the trade-offs that countries face between their blocking power and the power of the Council to act. The main findings are: (1) that the weights laid down in the Nice Treaty are close to being fair, the only significant discrepancies being the under representation of Germany and Romania, and the over representation of Spain and Poland; (2) the majority quota required for a decision is set too high for the Council of Ministers to be an effective decision making body.
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WORKING PAPER NO 586
The Efficiency, Equity and Politics of Emission Permit Trading
Myrna Wooders and Ben Zissimos

This paper illustrates that an international permit trading system may hurt relatively poor countries by making associated economic activities
unaffordable. A model is constructed in which the free market solution is Pareto inefficient as a result of pollution. The introduction of tradable permits allows pollution to be internalised, and brings about an increase in the total social surplus. But when incomes vary, this may not lead to a Pareto improvement; those in poor countries stop the polluting activity because they cannot afford to do otherwise. Only those in relatively rich countries are made better off. This may explain why poor countries are reluctant to ratify the Kyoto Protocol, itself advocating a permit trading scheme. The politico-economic implications of permit trading are also examined. We show that the democratic requirements for ratification impose a lower bound on pollution reduction that can be achieved through a system of pollution permits with trade.
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WORKING PAPER NO 585
Axiomatization of Ratio Equilibria in Public Good Economies
A. van den Nouweland, S. Tijs and M.H. Wooders

Using consistency properties, we characterize the cost-sharing scheme arising from the ratio equilibrium concept for economies with public goods. The characterization turns out to be surprisingly simple and direct. In contrast to most axiomatic characterizations based on reduced games and consistency properties, our characterization requires that in the reduced game, the players take as given the proportions of the costs paid by the members of the complementary player set, rather than their utility levels.
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WORKING PAPER NO 584

Does the Choice of University Matter? A Study of the Differences across UK Universities in Life Sciences Students' Degree Performance
Massimiliano Bratti

This paper investigates differences across UK universities in 1993 life
sciences students’ degree performance using individual-level data from
the Universities’ Statistical Record (USR). Differences across universities
are analysed by specifying and estimating a subject-specific educational
production function. Even after including a wide range of controls
for the quality of students, significant differences emerge across
universities in students’ degree performance. We apply a two-stage estimation procedure and find evidence that a large part of ‘university
effects’ cannot be explained by the kind of institutional inputs commonly
used in the literature on school quality. Finally, we compare the
unadjusted ranking of universities based on the proportion of ‘good’
(first and upper second class honours) degrees awarded with that based
on the estimated probability of a ‘good’ degree obtained from the microeconometric model and find significant differences between the two
indicators of universities’ performance.
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