Guofu Tan

The Economics of Hubs: The Case of Monopoly

In this paper, we study the optimization problem of an unregulated air carrier which is given the exclusive right to satisfy demand for air travel between any pair of cities. It chooses a network of connections and a set of prices to maximize profits. Thus, both network design and prices are endogenous. We characterize the solution to this optimization problem when demands and costs are symmetric. Our main result is that, if there are economies of density in the number of individuals travelling between two directly connected cities, the optimal network is either a hub of size n − 1 or one in which every pair of cities is connected directly.

ENTRY AND EXIT IN HUB-SPOKE NETWORKS

We offer an explanation for why regional carriers may not survive in hub-spoke networks. When a regional carrier and a hub operator compete in a spoke market, both will suffer losses in that market. But if the hub operator exists in the spoke market, its profits in connecting markets will fall. As long as the number of such markets is large enough, it is a dominant strategy for the hub operator not to exit from the spoke market. The regional carrier is then forced to exit, assuming fixed costs are not sunk.

Entry and R & D in procurement contracting

Abstract A model of competitive procurement and contracting is presented in this paper. The key features of the model include precontract R & D, an endogenous number of homogeneous firms, and sealed-bid auction rules. Both diminishing and constant returns to scale (DRS and CRS) in R & D expenditure technologies are considered. I find that the sealed-bid first-price auction (FPA) is equivalent to the second-price auction (SPA) under DRS technology. The Revenue Equivalence Theorems breaks down under CRS because multiple equilibria arise in the R & D stage when SPA is used. Howerer, SPA yields a unique perfect equilibrium given sufficient heterogeneity among potential firms. The free-entry perfect equilibrium is also characterized. The buyer prefers free entry through an appropriate selection of the reservation price.

Equilibria in networks

We study a model in which two carriers choose networks to connect cities and compete for travelling customers. We show that if carriers compete aggressively (e.g., Bertrand-like behavior), one carrier operating a single hub-spoke network is an equilibrium outcome. Competing hub-spoke networks are not an equilibrium outcome, although duopoly equilibria in non-hub networks can exist. If carriers do not compete aggressively, a duopoly equilibrium in hub-spoke networks exists if the number of cities is not small. We provide conditions under which all equilibria consist of hub-spoke networks.

Cost-Reducing Investment, Optimal Procurement and Implementation by Auctions

The authors analyze a model in which potential suppliers invest in research and development (R&D) and then compete for a procurement contract from a buyer. If the buyer is able to commit to a procurement mechanism before the investment stage, the full-information solution can be uniquely implemented by first-price and second-price sealed-bid auction mechanisms when the R&D technology exhibits decreasing returns to scale. If the procurement mechanisms and the levels of investment are chosen simultaneously, the full-information solution cannot be implemented. The authors discuss how the second-best equilibrium contract varies with the number of suppliers. Copyright 1996 by Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association.

Strategic incentives of divestitures of competing conglomerates

Abstract We provide an alternative theory of divestiture that relies on product-line complementarities and product market competition. We show that in equilibrium competing conglomerates with complementary product lines have incentives to divest and that such divestitures increase both the prices of all the products and the profits of the parent firms, but reduce total surplus. We further show that if the firms are able to coordinate their divestiture strategies, monopoly prices and profits can be achieved via a non-cooperative pricing game.

Optimal procurement mechanisms for an informed buyer

This paper studies a buyer (e.g., a government agency) offering a procurement contract to a number of privately informed suppliers. The buyer has private information about her demand for the product to be procured. The optimal mechanisms for all types of the buyer are examined. It is optimal for the buyer to reveal her demand information through the contract offer and use a first-price sealed-bid auction procedure to award the contract, announcing her reserve price in advance. Any second-price auction is shown to yield less expected surplus for the buyer than the optimal first-price auction does when the buyers marginal willingness to pay decreases with quantity.

Bidding Rings and the Winner's Curse: The Case of Federal Offshore Oil and Gas Lease Auctions

This paper extends the theory of legal cartels to affiliated private value and common value environments, and applies the theory to explain joint bidding patterns in U.S. federal government offshore oil and gas lease auctions. We show that efficient collusion is always possible in private value environments, but may not be in common value environments. In the latter case, fear of the winners curse can cause bidders not to bid, which leads to inefficient trade. Buyers with high signals may be better off if no one colludes. The bid data is consistent with oil and gas leases being common value assets, and with the prediction that the winners curse can prevent rings from forming on marginal tracts.

An arbitration game and the egalitarian bargaining solution

We analyze a simple arbitration procedure which is a multi-stage variant of Nashs demand game. In the absence of discounting, all Nash equilibria of the game yield the egalitarian solution in the first stage. The crucial feature of our arbitration procedure is that, in the case of incompatible demands, the game is allowed to continue and the player who demands the higher gain over the disagreement point is penalized by restricting her or his feasible demands in the following stage. Suitable modifications of the arbitration game yield the lexicographic extension of the egalitarian solution, resp. the proportional solutions. Journal of Economic Literature Classification Numbers: C72, C78.

The Market for Sweepstakes

This paper studies the market for monopolistically supplied sweepstakes. We derive equilibrium demands for fixed-prize and variable-prize sweepstakes and determine the profit-maximizing prize level and pay-out ratio respectively. It can be profitable to offer each type of sweepstake when there is a large enough number of weighted utility consumers who have constant absolute risk attitudes, are strictly averse to small as well as symmetric risks, and display longshot preference behaviour. Moreover, for the variable-prize sweepstake, the supplier will generally find it profitable to combine sweepstakes targeting two smaller populations, and offer a single sweepstake to the combined population. This implication is corroborated by the recent spate of mergers of smaller state lotteries into larger ones. Copyright 2005, Wiley-Blackwell.