Testing threats in repeated games

Under most game-theoretic solution concepts, equilibrium beliefs are justified by off-equilibrium events. I propose an equilibrium concept for infinitely repeated games, called "Nash Equilibrium with Tests" (NEWT), according to which players can only justify their equilibrium beliefs with events that take place on the equilibrium path itself. In NEWT, players test every threat that rationalizes a future non-myopic action that they take. The tests are an integral part of equilibrium behavior. Characterization of equilibrium outcomes departs from the classical "folk theorems". The concept provides new insights into the impact of self-enforcement norms, such as reciprocity, on long-run cooperation. (c) 2004 Elsevier Inc. All rights reserved

Monopoly pricing when consumers are antagonized by unexpected price increases: a "cover version" of the Heidhues-Koszegi-Rabin model

This paper reformulates and simpli�fies a recent model by Heidhues and Koszegi (2005), which in turn is based on a behavioral model due to Koszegi and Rabin (2006). The model analyzes optimal pricing when consumers are loss averse in the sense that an unexpected price hike lowers their willingness to pay. The main message of the Heidhues-Koszegi model, namely that this form of consumer loss aversion leads to rigid price responses to cost fluctuations, carries over. I demonstrate the usefulness of this "cover version" of the Heidhues-Koszegi-Rabin model by obtaining new results: (1) loss aversion lowers expected prices; (2) the firm's incentive to adopt a rigid pricing strategy is stronger when fluctuations are in demand rather than in costs

COMMENTS ON THE POTENTIAL SIGNIFICANCE OF NEUROECONOMICS FOR ECONOMIC THEORY

In this short note I speculate about the various ways in which the study of neurological aspects of decision making could be fruitful for economic modelling

Simplicity of beliefs and delay tactics in a concession game

I explore the idea of simplicity as a belief-selection criterion in games. A pair of strategies in finite-automata representation (s(1), s(2)) is a Simple Nash Equilibrium (SINE) if: (1) s(j) is a best-reply to s(i); (2) every automaton for player j, which generates the same path as s(j) (given s(i)), has at least as many states as s(j). I apply SINE to a bilateral concession game and show that it captures an aspect of bargaining behavior: players employ delay tactics in order to justify their concessions. Delay tactics are mutually reinforcing, and this may prevent players from reaching an interior agreement. (C) 2003 Elsevier Inc. All rights reserved

"But can't we get the same thing with a standard model?" Rationalizing bounded-rationality models

This paper discusses a common criticism of economic models that depart from the standard rational-choice paradigm - namely, that the phenomena addressed by such models can be “rationalized” by some standard model. I criticize this criterion for evaluating bounded-rationality models. Using a market model with boundedly rational consumers due to Spiegler (2006a) as a test case, I show that even when it initially appears that a bounded-rationality model can be rationalized by a standard model, the rationalizing models tend to come with unwarranted “extra baggage”. I conclude that we should impose a greater burden of proof on rationalizations that are offered in refutation of such models

Can anticipatory feelings explain anomalous choices of information sources?

The well-being of agents is often directly affected by their beliefs, in the form of anticipatory feelings such as anxiety and hopefulness. Economists have tried to model this effect by introducing beliefs as arguments in decision makers' vNM utility function. One might expect that such a model would be capable of explaining anomalous attitudes to information that we observe in reality. We show that the model has several shortcomings in this regard, as long as Bayesian updating is retained. (c) 2005 Elsevier Inc. All rights reserved

A simple model of search engine pricing

We present a simple model of how a monopolistic search engine optimally determines the average quality of firms in its search pool. In our model, there is a continuum of consumers, who use the search engine’s pool, and there is a continuum of firms, whose entry to the pool is restricted by a price set by the search engine. We show that a monopolistic search engine may have an incentive to set a relatively low price that encouarges low-relevance advertisers to enter the search pool. This conclusion is independent of whether the search engine charges a price per click or a fixed access fee

On the strategic use of attention grabbers

When a �firm decides which products to offer or put on display, it takes into account the products' ability to attract attention to the brand name as a whole. Thus, the value of a product to the �firm emanates from the consumer demand it directly meets, as well as the indirect demand it generates for the firms other products. We explore this idea in the context of a stylzed model of competition between media content providers (broadcast TV channels, internet portals, newspapers) over consumers with limited attention. We characterize the equilibrium use of products as attention grabbers and its implications for consumer conversion, industry profi�ts and (mostly vertical) product differentiation

Contradiction as a form of contractual incompleteness

A simple model is presented, in which contradictory instructions are viewed as a type of contract incompleteness. The model provides a complexity-based rationale for contradictory instructions. If there are complexity bounds on the contract, there may be an incentive to introduce contradictions, leaving for another agent the task of interpreting them. The optimal amount of contradictions depends on the complexity bound, the conflict of interests with the interpreter, and the institutional constraints on his interpretations. In particular, a higher complexity bound may result in a larger amount of contradictions

Consumer optimism and price discrimination

In many principal-agent environments, the two parties hold different prior beliefs regarding the agent's future preferences. These differences may be due to inherent biases such as over-optimism or over-pessimism. We analyze the principal's optimal contract design under the assumption that the agent's prior is private information. In order to screen the agent's prior, the principal devises a menu of contingent contracts, some of which are 'speculative' as they involve betting on the agent's future action. We characterize the optimal menu and show that the characterization enables us to interpret real-life contract design in a variety of economic contexts