Stephen McCafferty

Dynamic duopoly with adjustment costs: A differential game approach

Abstract This paper develops a differential-game model of duopoly, in which firms incur costs associated with how fast they change their level of output. The analysis solves for a subgame perfect equilibrium to the model in which the steady-state level of output lies strictly between the static Cournot and perfect competition solutions. Furthermore, we demonstrate that the limit game in which the speed of adjustment parameter approaches zero does not tend toward the static Cournot equilibrium.

Speculation, rational expectations, and stability of the foreign exchange market

Abstract This paper uses Muths model of rational expectations to analyze foreign exchange speculation under floating exchange rates when a trade balance ‘J-curve effect’ exists. It extends the existing literature by basing speculative behavior explicity on maximizing behavior, by relating expectations to the underlying structure of the model, i.e. by assuming rational expectations, and by explicitly incorporating uncertainty. A surprising result is that, if speculation takes place, decreases in risk aversion increase the variance of the exchange rate.

Monopoly and Oligopoly Provision of Addictive Goods

This article investigates monopoly and oligopoly provision of an addictive good. Consumer preferences are modeled as in Becker and Murphy (1988). Addictive goods have characteristics that create interesting strategic issues when suppliers are noncompetitive. We characterize the perfect Markov equilibrium of a market with noncompetitive supply of an addictive good and compare it with the efficient solution. Depending on particular parameter values, we find a wide variety of possible steady-state outcomes, including ones with output above the efficient level and price below marginal cost. We also find that market power can be disadvantageous.

Spot and forward rates in a stochastic model of the foreign exchange market

Abstract In this paper, we develop a simultaneous stochastic model of spot and forward exchange-rate determination under rational expectations. For spot rates, we find that increases in speculative responsiveness dampen the effects of trade-balance shocks, but exacerbate effects of interest-rate shocks. For forward rates, though, increases in speculative responsiveness dampen the effects of both trade-balance and interest-rate shocks. The bias of the forward forecast error decreases as specualtive responsiveness increases, but the expected squared error may increase.

Comparing vertical restraints

Abstract When faced with the need to protect dealer provision of promotional services for their products, manufacturers have continued to impose resale price maintenance (RPM) in preference to providing exclusive territories, even though the latter are legal while RPM is not. This paper compares RPM and territories, finding that RPM raises retail prices by less, but also supports less service provision than the exclusive territories alternative. Indeed, exclusive territories raise prices and generate more services than full manufacturer integration into distribution. This result calls into question the current contrasting legal treatment of territories and RPM.

Industrial policy and duopolistic trade with dynamic demand

The authors study strategic trade policy in the framework of an explicit dynamic game in which home and foreign duopolists compete in a third-country market for non-competitive rents. Dynamics are introduced on the demand side by assuming demand for the product depends on past consumption of that good. The analysis demonstrates that the perfect equilibrium of the dynamic game can be replicated by a conjectural variations equilibrium, and that optimal policy requires a tax on exports.

Exchange rate dynamics with wealth effects: Some theoretical ambiguities

Abstract This paper helps fill in a remaining gap in the exchange rate dynamics literature: the role of wealth and relative-price effects. The analysis differs from Dornbusch (1976) in the inclusion of wealth effects. It differs from Engel and Flood (forthcoming) in the inclusion of relative-price effects in the savings function. The basic result of the paper is that when relative price effects dominate wealth effects, exchange rate undershooting occurs, but when wealth effects dominate, overshooting may occur.

Exchange-rate determination: An equilibrium approach with imperfect capital substitutability

Abstract Two stylized facts of the open economy are often considered prima facie evidence of goods-market disequilibrium: persistent deviations of relative prices from purchasing power parity, and the higher variability of the nominal exchange rate relative to price levels. We develop an equilibrium model characterized by imperfect goods and asset substitutability across countries, and show how it is consistent with the aforementioned stylized facts. We also show that increases in the degree of risk aversion of speculators leads to higher exchange-rate variance if shocks are monetary.

Existence and uniqueness of stochastic equilibrium in a simple macro model

Abstract This paper demonstrates that even the simplest rational expectations macro model may be plagued by nonexistent or multiple equilibria. The reason for these problems is the postulated existence of risk-averse behavior on the part of labor suppliers and purchasers of durable commodities. This risk-averse behavior introduces the price forecast variance into the behavioral parameters of the model, thus leading to a simultaneous nonlinear system.

The workings of a commodity money system in an incomplete information macro model

Abstract This paper compares the properties of a token money system with that of a commodity money system in an uncertain environment. In an incomplete information world, relative prices are not known with certainty. However, a commodity money system provides some information because the nominal price of the monetary commodity is known. The benefits of this information-enhancing function may be offset, though by distortions in relative prices relative to their full information Walrasian equilibrium values. Because the two systems have vastly different structural parameters, we cannot unambiguously state which system is welfare superior.