Games Suppliers and Producers Play : Upstream and Downstream Moral Hazard with Unverifiable Input Quality

We pin down the optimal relational contract between an input supplier and a final goods producer given a framework of bilateral moral hazard with variable but non-verifiable input quality. Given the inability of third parties to verify input quality, each party has an incentive to cheat the other by making a false claim about input quality. We derive the contract which (a) induces honest behavior and brings about the Pareto superior first-best outcome for the widest possible range of exogenous parameters, and (b) maximizes the Nash product of both parties payoffs subject to incentive compatibility. An interesting feature of the optimal contract is that it is of a fixed-price variety with the final producer paying the supplier the same transfer price whether he has been supplied a high or low quality input when the agreement was to supply high quality. This contrasts with the traditional incomplete contracting literature where fixed-price contracts (eg, payment of a fixed wage to workers) was optimal only in the full information case while ours is a case of incomplete information. The contrast is rooted both in the bilateral nature of the moral hazard we consider and in the repeated game framework we use. We also pinpoint the exact transfer price in the optimal contract, which may vary for different parameter ranges, and show how the best contract differs from the optimal contract under complete contracting.Incomplete contracting, upstream and downstream moral hazard, repeated games, Nash bargaining

Sex Ratios, Divorce Laws and the Marriage Market

We show how an interaction between the skewness of the sex ratio and the jump in divorce rates after a liberalization in divorce laws can obtain in a model of marriage market matching with non-transferable utility. This model is partly motivated by a significant cross-country correlation between these two variables. We also find that men’s hopes or fears about women’s marriage market odds are self-confirming under mutual consent, resulting in multiple equilibria. The multiplicity vanishes with a more skewed sex ratio or a liberalization of divorce laws. Our work sheds some light on the possible implications of divorce liberalization and pro-marriage policies.Divorce, sex ratios, marriage, skewness, matching, non-transferable utility.

Trade, Growth and Increasing Returns to Infrastructure : The Role of the Sophisticated Monopolist

We model an economy with two final goods, manufactures produced under IRS and food. The scale economies in manufacturing are external (therefore compatible with perfect competition) and traceable to internal economies in the provision of an infrastructural service (the third sector of the economy). We examine the equilibria of this economy under both autarky and free trade. We thus revisit a theme with a voluminous literature, beginning with R. C. O. Matthews(1950) vintage classic and including, among others, Panagariya (1991), Krugman (1991), and Venables (1996). Much of this as well as our own work concerns multiple equilibria : it overlaps the development literature on poverty traps from Rosenstein Rodan (1943) to Murphy, Schleifer and Vishny (1989). We differ from this body of work in a major, and some minor, respects. We trace the source of increasing returns to infrastructure, and our focus is on the role of the infrastructure providers beliefs in determining the equilibrium and the fate of the economy. Internal economies in infrastructure provision ensure that it is non-competitive . We consider a pure monopoly. The infrastructure provider is of course aware of the impact of his decisions on the price of his services, but he may or may not appreciate their impact, on demand for labor (in a market where he competes with all other industrial and agricultural producers) and wages and induced effects on demand for infrastructure itself. He may in short be a nave or a sophisticated decision-maker. We model the nave infrastructure provider after Venables (1996). Venables portrays a producer of intermediates who derives the demand curve for his product on the assumption that his customers have already contracted for their purchases of other inputs, specifically labor. Similar beliefs on the part of our infrastructure provider generate an equilibrium that is unique in the closed economy. In the small open economy, on the other hand, equilibria, where they exist , will generally be multiple : at any world price, there will generally exist one at a low level with unexhausted scale economies and another at a high level where these have been exhausted.Increasing returns to scale, cognitive hierarchy, multiple equilibria, uniqueness, Cournot oligopoly

Green Revolutions and Miracle Economies : Agricultural Innovation, Trade and Growth

The purpose of this paper is to develop a simple model of an economy in which growth is driven by a combination of exogenous technical change in agriculture as well as by a rising world demand for labor-intensive manufactured exports. We explore the relative roles of agricultural innovation and rising export demand in a model with two traded industrial goods and a non-traded agricultural good, food. When the non-traded sector uses a specific factor, we show that technical change in agriculture may be the key to sustained factor accumulation in industry, in particular driving intersectoral labor migration. A key assumption is a less than unitary price elasticity of demand for food. Our results could form a crucial link in capturing the story of labor-abundant economies which experienced structural transformation and growth through labor-intensive manufactured exports, without prior technology breakthroughs in industry. They contribute to explaining the massive growth in factor accumulation which shows up in some growth accounting studies : they may also imply that some of the contribution of technical progress is mistakenly attributed solely to factor accumulation.Structural change, Agricultural productivity, labor migration, Terms of Trade

The Case of the Errant Executive : Management, Control and Firm Size in Corporate Cheating

Firm insiders a manager and a board face moral hazard in relation to their outside shareholders in a repeated game with asymmetric information and stochastic market outcomes. The manager determines whether or not outsiders are cheated; the board, whose objectives differ from those of outside shareholders, attempts to control the manager through compensation contracts and dismissal threats Since compensation determines the managers incentive to cheat, firms competing for outside capital publicly announce their managerial contracts. However, secret renegotiation between firm and manager is still possible : so outsiders guard against being cheated by limiting their total stake in any firm. This imposes a credibility constraint on firm size, providing a rationale for the shape of long-run cost curves. Given this limit on outside funds, the minimum size requirement for enterprises to become operational and the ability to pay managers enough to ensure honesty both set a floor to the personal wealth required to enter entrepreneurship. Thus, we endogenize entry into industry, establish a unique equilibrium for any distribution of wealth, and characterize different equilibria. We also explain features of poor countries like dominance of family firms, moral hazard induced vicious circles that retard industrialization and the stimulus that inequality may provide to industrial development.moral hazard, firm size, managerial compensation, repeated games

Green Revolutions and Miracle Economies : Agricultural Innovation, Trade and Growth

The purpose of this paper is to develop a simple model of an economy in which growth is driven by a combination of exogenous technical change in agriculture as well as by a rising world demand for labor-intensive manufactured exports. We explore the relative roles of agricultural innovation and rising export demand in a model with two traded industrial goods and a non-traded agricultural good, food. When the non-traded sector uses a specific factor, we show that technical change in agriculture may be the key to sustained factor accumulation in industry, in particular driving intersectoral labor migration. A key assumption is a less than unitary price elasticity of demand for food. Our results could form a crucial link in capturing the story of labor-abundant economies which experienced structural transformation and growth through labor-intensive manufactured exports, without prior technology breakthroughs in industry. They contribute to explaining the massive growth in factor accumulation which shows up in some growth accounting studies : they may also imply that some of the contribution of “technical progress” is mistakenly attributed solely to factor accumulation.Structural change, agricultural productivity, labor migration, terms of trade.

Maids and mistresses : migrating maids and female labor force participation

We model the linkage between immigration of maids and intersectoral movements of female family labor in a small open economy with a competitive factory sector and a household sector which employs both immigrant maids and family labor. We show that relaxing immigration restrictions on maids will not necessarily increase participation by family labor in the formal workforce. We also show that reducing taxes on employment of maids will not necessarily increase labor force participation by local women – instead, imposing a tax (where there are none) may trigger such an increase depending on maids' and locals'' relative propensities to consume household sector output. Our analysis sheds light on one facet of the penetration of the household sector by market forces and yields some unexpected policy implications.

Games Suppliers and Producers Play : Upstream and Downstream Moral Hazard with Unverifiable Input Quality

We pin down the optimal relational contract between an input supplier and a final goods producer given a framework of bilateral moral hazard with variable but non-verifiable input quality. Given the inability of third parties to verify input quality, each party has an incentive to cheat the other by making a false claim about input quality. We derive the contract which (a) induces honest behavior and brings about the Pareto superior “first-best” outcome for the widest possible range of exogenous parameters, and (b) maximizes the Nash product of both parties’ payoffs subject to incentive compatibility. An interesting feature of the optimal contract is that it is of a “fixed-price” variety with the final producer paying the supplier the same transfer price whether he has been supplied a high or low quality input when the agreement was to supply high quality. This contrasts with the traditional incomplete contracting literature where fixed-price contracts (eg, payment of a fixed wage to workers) was optimal only in the full information case – while ours is a case of incomplete information. The contrast is rooted both in the bilateral nature of the moral hazard we consider and in the repeated game framework we use. We also pinpoint the exact transfer price in the optimal contract, which may vary for different parameter ranges, and show how the best contract differs from the optimal contract under complete contracting.Incomplete contracting, upstream and downstream moral hazard, repeated games, Nash bargaining.

Utility functions, future consumption targets and subsistence thresholds

If the consumers risk aversion behavior varies intertemporally and if the risk aversion coefficient on future consumption becomes very large, the consumer tends to aim at a fixed future consumption target. A by-product is a reinterpretation of subsistence theories of consumption.Intertemporal Consumer Choice, theories of consumption, risk aversion coefficient

Utility functions, future consumption targets and subsistence thresholds

If the consumer's risk aversion behavior varies intertemporally and if the risk aversion coefficient on future consumption becomes very large, the consumer tends to aim at a fixed future consumption target. A by-product is a reinterpretation of subsistence theories of consumption.