Learning-by-Doing, Organizational Forgetting, and Industry Dynamics

Learning-by-doing and organizational forgetting have been shown to be important in a variety of industrial settings. This paper provides a general model of dynamic competition that accounts for these economic fundamentals and shows how they shape industry structure and dynamics. Previously obtained results regarding the dominance properties of firms' pricing behavior no longer hold in this more general setting. We show that forgetting does not simply negate learning. Rather, learning and forgetting are distinct economic forces. In particular, a model with learning and forgetting can give rise to aggressive pricing behavior, market dominance, and multiple equilibria, whereas a model with learning alone cannot.

Dynamic game under ambiguity: the sequential bargaining example, and a new "coase conjecture"

Conventional Bayesian games of incomplete information are limited in their ability to represent severe incompleteness of information. Using an illustrative example of (seller offer) sequential bargaining with one-sided incomplete information, we analyze a dynamic game under ambiguity. The novelty of our model is the stark assumption that the seller has complete ignorance---represented by the set of all plausible prior distributions---over the buyer's type. We propose a new equilibrium concept---Perfect Objectivist Equilibrium (POE)---in which multiple priors and full Bayesian updating characterize the belief system, and the uninformed player maximizes the infimum expected utility over non-weakly-dominated strategies. We provide a novel justification for refining POE through Markov perfection, and obtain a unique refined equilibrium. This results in a New "Coase Conjecture"---a competitive outcome arising from an apparent monopoly, which does not require the discount rate to approach zero, and is robust to reversion caused by reputation equilibria

Competitive Equilibrium in the Credit Market under Asymmetric Information

We study a competitive credit market equilibrium in which all agents are risk neutral and lenders a priori unaware of borrowers' default probabilities. Admissible credit contracts are characterized by the credit granting probability, the loan quantity, the loan interest rate and the collateral required. The principal result is that in equilibrium lower risk borrowers pay higher interest rates than higher risk borrowers; moreover, the lower risk borrowers get more credit in equilibrium than they would with full information. No credit is rationed and collateral requirements are higher for the lower risk borrowers.

The Economics of Predation: What Drives Pricing When There is Learning-by-Doing?

We formally characterize predatory pricing in a modern industry-dynamics framework that endogenizes competitive advantage and industry structure. As an illustrative example we focus on learning-by-doing. To disentangle predatory pricing from mere competition for efficiency on a learning curve we decompose the equilibrium pricing condition. We show that forcing firms to ignore the predatory incentives in setting their prices can have a large impact and that this impact stems from eliminating equilibria with predation-like behavior. Along with predation-like behavior, however, a fair amount of competition for the market is eliminated

Is Dynamic Competition Socially Beneficial? The Case of Price as Investment

We study industries where prices are not limited to their allocative and distributive roles, but also serve as an investment into lower costs or higher demand. While our model focuses on learning-by-doing and the cost advantage that it implies, our conclusions also apply to industries driven by network externalities. Existing literature does not have a clear verdict on whether the investment role of prices benefits or hurts the overall welfare, as there are a number of economic forces at work, e.g. motivation to move down the learning curve faster could be offset by the ease of driving a weaker rival out of the market. We compute both market equilibrium and first-best solution. The resulting deadweight loss appears small, in the sense that eliminating the investment motive from pricing decisions leads to much worse outcomes. Further investigation into components of deadweight loss shows that while pricing distortions are the most important driver of the deadweight loss, these distortions can be fairly small. Entry-exit distortions that arise from duplicated set-up and fixed opportunity costs also contribute to the deadweight loss, but these distortions are partially offset by more beneficial industry structure, as the market equilibrium tends to result in more active firms than the first-best solution

Subsidizing research programs with "if" and "when" uncertainty in the face of severe informational constraints

We study government optimal subsidy policies for research programs in the face of servere information asymmetry---when firms have private information about the likelihood of project viability but the government cannot form a unique prior belief about this likelihood. The paper makes two contributions. First, we show that the way in which R&D is subsidized matters. Under both monopoly R&D (i.e., a single firm conducts R&D in isolation) and R&D competition, different types of subsidies (e.g., earmarked, unrestricted subsidies, and pure matching subsidies) have significantly different effects on firms' R&D investment incentives. Second, we show that a simple subsidy scheme works even when the government is unable to form a unique prior belief about the firm's private information on project viability. If the shadow cost of public funds is zero, under monopoly R&D, there exists a pure matching subsidy that induces the firm to follow the first-best R&D policy irrespective of its prior beliefs about the viability of the project, meaning it is a (belief-free) ex post equilibrium policy; under R&D competition, the first-best outcome can also be achieved through a simple combination of a matching subsidy and an unrestricted subsidy. If the shadow cost of public funds is positive, an ex post equilibrium in general does not exist either under monopoly or competition. We then consider two alternative policy decision criteria that are appropriate for belief-free games: rationalizability and max-min criteria. We argue that the max-min criteria is preferable in our context, and by way of doing so establish that the set of max-min subsidy policies under either monopoly or competitive R&D consists entirely of simple pure matching subsidies. We further establish that allowing firms to form an R&D consortium reduces the matching rate for the highest max-min subsidy, suggesting that cooperative R&D has the potential to economize on the shadow costs of public funding of subsidies

Learning-by-Doing, Organizational Forgetting, and Industry Dynamics

Learning-by-doing and organizational forgetting are empirically important in a variety of industrial settings. This paper provides a general model of dynamic competition that accounts for these fundamentals and shows how they shape industry structure and dynamics. We show that forgetting does not simply negate learning. Rather, they are distinct economic forces that interact in subtle ways to produce a great variety of pricing behaviors and industry dynamics. In particular, a model with learning and forgetting can give rise to aggressive pricing behavior, varying degrees of long-run industry concentration ranging from moderate leadership to absolute dominance, and multiple equilibria

Lumpy Capacity Investment and Disinvestment Dynamics

Capacity addition and withdrawal decisions are among the most important strategic decisions made by firms in oligopolistic industries. In this paper, we develop and analyze a fully dynamic model of an oligopolistic industry with lumpy capacity and lumpy investment/disinvestment. We use our model to suggest answers to two questions: First, what economic factors facilitate preemption races? Second, what economic factors facilitate capacity coordination? With a series of examples we show that low product differentiation, low investment sunkness, and high depreciation tend to promote preemption races. The same examples also show that low product differentiation and low investment sunkness tend to promote capacity coordination. Although depreciation removes capacity, it might impede capacity coordination. Finally, our examples show that multiple equilibria arise over at least some range of parameter values. The distinct structures of these equilibria suggest that firms’ expectations play a key role in determining whether or not industry dynamics are characterized by preemption races and capacity coordination. Taken together, our results suggest that preemption races and excess capacity in the short run often go hand-in-hand with capacity coordination in the long run

Relationship Banking, Deposit Insurance and Bank Portfolio Choice

The purpose of this paper is to examine the consequences of interbank competition and bank-capital market competition on the portfolio choices of banks and the welfare of borrowers in a regulatory environment of (de facto) complete deposit insurance. Our focus is on an industry characterized by 'relationship banking', i.e. a setting involving repeated, bilateral credit transactions between banks and borrowers. A key feature of relationship banking is the intertemporal accumulation of proprietary borrower-specific information in the hands of the bank, and the consequent creation of informational rents. To the extent that these rents are shared by the bank and the borrower, both parties see a value in continuing their relationship. The desire to protect such relationships affects the bank's asset portfolio choice.