Competition Among Institutions

Economic theory offers two different approaches to the analysis of group formation and the role of institutions. The general equilibrium approach explores the influence of the economic environment on the formation of groups. The game theoretic approach runs in the opposite direction; it explores the influence of institutions on economic outcomes. To integrate these approaches we consider situations in which institutions must compete for members. Our focus is on the fundamental interaction between memberships and policies. The policy that an institution adopts depends on its membership, while its membership depends on the policies of all the institutions. We provide the basic elements for a theory of competition among institutions: an abstract definition of an institution and the corresponding equilibrium concepts. We demonstrate by example, the possibility that equilibrium may not exist. In the absence of a general existence result, we pursue three different avenues. We begin with existence results based on maximization of a utilitarian social welfare function. This places strong restrictions on the decision-making process, although it covers a number of interesting political applications. This is followed by a continuity-based approach. Although quite general, it relies critically on an assumption that the institutions have certain idiosyncratic features. To handle cases without idiosyncrasies, we turn to an algebraic approach. Although existence is established, the result depends on the dimensionality of the problem. Together, these avenues provide a broad class of models for which equilibrium exists, covering cases with multiple dimensions, multiple institutions, and general institutional decision-making processes

One-Way Essential Complements

While competition between firms producing substitutes is well understood, less is known about rivalry between complementors. We study the interaction between firms in markets with one-way essential complements. One good is essential to the use of the other but not vice versa, as arises with an operating system and applications. Our interest is in the division of surplus between the two goods and the related incentive for firms to create complements to an essential good. Formally, we study a two-good model where consumers value A alone, but can only enjoy B if they also purchase A. When one firm sells A and another sells B, the firm that sells B earns a majority of the value it creates. However, if the A firm were to buy the B firm, it would optimally charge zero for B, provided marginal costs are zero and the average value of B is small relative to A. Hence, absent strong antitrust or intellectual property protections, the A firm can leverage its monopoly into B costlessly by producing a competing version of B and giving it away. For example, Microsoft provided Internet Explorer as a free substitute for Netscape; in our model, this maximizes Microsoft’s joint monopoly profits. Furthermore, Microsoft has no incentive to raise prices, even if all browser competition exits. This may seem surprising since it runs counter to the traditional gains from price discrimination and versioning. We also show that a essential monopolist has no incentive to degrade rival complementary products, which suggests that a monopoly internet service provider will offer net neutrality. There are other means for the essential A monopolist to capture surplus from B. We consider the incentive to add a surcharge (or subsidy) to the price of B, or to act as a Stackelberg leader. We find a small gain from pricing first, but much greater profits from adding a surcharge to the price of B. The potential for A to capture B’s surplus highlights the challenges facing a firm whose product depends on an essential good

Aggregation and Social Choice: A Mean Voter Theorem

A celebrated result of Black (1984a) demonstrates the existence of a simple majority winner when preferences are single-peaked. The social choice follows the preferences of the median voter's most preferred outcome beats any alternative. However, this conclusion does not extend to elections in which candidates differ in more than one dimension. This paper provides a multi-dimensional analog of the median voter result. We show that the mean voter's most preferred outcome is unbeatable according to a 64%-majority rule. The weaker conditions supporting this result represent a significant generalization of Caplin and Nalebuff (1988). The proof of our mean voter result uses a mathematical aggregation theorem due to Prekopa (1971, 1973) and Borell (1975). This theorem has broad applications in economics. An application to the distribution of income is described at the end of this paper; results on imperfect competition are presented in the companion paper [CFDP 937].Median voter, voting, social choice, elections

Aggregation and Imperfect Competition: On the Existence of Equilibrium

We present a new approach to the theory of imperfect competition and apply it to study price competition among differentiated products. The central result provides general conditions under which there exists a pure strategy price equilibrium for any number of firms producing any set of products. This includes products with multi-dimensional attributes. In addition to the proof of existence, we provide conditions for uniqueness. Our analysis covers location models, the characteristic approach, and probabilistic choice together in a unified framework. To prove existence, we employ aggregation theorems due to Prekopa (1971) and Borell (1975). Our companion paper [CFDP 938] introduces these theorems and develops the application to super-majority voting rules.Imperfect competition, Bertrand equilibrium, differentiated products, prices, price competition

Prizes and Incentives: Towards a General Theory of Compensation and Competition

This article analyzes the role of competitive compensation schemes (in which pay depends on relative performance) in economies with imperfect information. These compensation schemes have desirable risk, incentive, and flexibility properties; they provide for an automatic adjustment of rewards and incentives in response to common changes in the environment. When environmental uncertainty is large, such schemes are shown to be preferable to individualistic reward structures; in the limit, as the number of contestants becomes large, expected utility may approach the first-best (perfect information) level. We study the design of contests, including the optimal use of prizes versus punishments and absolute versus relative performance standards. The analysis can also be viewed as a contribution to the multi-agent, single-principal problem

The Welfare Effects of Metering Ties

Critics of current tying doctrine argue that metering ties can increase consumer welfare and total welfare without increasing output and that they generally increase both welfare measures. Contrary to those claims, we prove that metering ties lower consumer welfare and total welfare unless they increase capital good output. We further provide conditions under which metering ties always harm consumer welfare for all uniform and lognormal distributions of consumable usage rates. Finally, we show that with a lognormal distribution, metering ties also lower total welfare absent a large dispersion in desired usage of the metered good. These findings support current tying doctrine, which presumptively condemns ties with market power absent proof of an offsetting procompetitive justification

Equilibrium Unemployment as a Worker Screening Device

We present a model of the labor market with asymmetric information in which the equilibrium of the' market generates unemployment and job queues so that wages may serve as an effective screening device. This happens because more productive workers -- within any group of individuals with a given set of observable characteristics -- are more willing to accept the risk of being unemployed than less productive workers. The model is consistent with cyclical movements in average real wages as well as with differences in unemployment rates across different groups in the population. We also show that the market equilibrium is not, in general. constrained Pareto efficient Moreover. we identify a new category of nonexistence problems, different in several essential ways from those earlier discussed by Rothschild-Stiglitz [1976J and Wilson [1977]. We also extend the analysis to incorporate the possibility of renegotiation, showing that a separating-renegotiation-proof-equilibrium exists for certain parameters and that a renegotiation-proof equilibrium is always constrained Pareto efficient Finally, we present a version of the model in which firms enter sequentially, as in Guash and Weiss [1980]. But contrary to the main result in that paper, we show that there is no advantage of being late, provided workers have rational expectations.

Competing Complements

In Cournot's model of complements, the producers of A and B are both monopolists. This paper extends Cournot's model to allow for competition between complements on one side of the market. Consider two complements, A and B, where the A + B bundle is valuable only when purchased together. Good A is supplied by a monopolist (e.g., Microsoft) and there is competition in the B goods from vertically differentiated suppliers (e.g., Intel and AMD). In this simple game, there may not be a pure-strategy equilibria. In the standard case where marginal costs are weakly positive, there is no pure strategy where the lower quality B firm obtains positive market share. We also consider the case where A has negative marginal costs, as would arise when A can expect to make upgrade sales to an installed base. When profits from the installed base are sufficiently large, a pure strategy equilibrium exists with two B firms active in the market. Although there is competition in the complement market, the monopoly Firm A may earn lower profits in this environment. Consequently, A may prefer to accept lower future profits in order to interact with a monopolist complement in B