Thomas W. Ross

Product Warranties and Double Moral Hazard

This article explores a model of warranties in which moral hazard problems play a key role. The goal is to understand the important characteristics of warranties, including their provision of incomplete insurance and the relationship between product quality and coverage. We analyze a model in which buyers and sellers take actions that affect a products performance. Since these actions are not cooperatively determined, an incentives problem arises. We characterize the optimal warranty contract and undertake comparative statics to determine the predicted correlation of warranty coverage and product quality.

Communication in the Battle of the Sexes Game: Some Experimental Results

We report experimental results on the role of preplay communication in a one-shot, symmetric battle of the sexes game. We conducted games in which there was no communication, and we studied the effects of three different communication structures: one-way communication with one round of messages and two-way communication with one round as well as three rounds of messages. With these messages, each player could indicate which action he planned to take. Communication significantly increased the frequency of equilibrium play. One-way communication was most effective in resolving the coordination problem. While there was more conflict with two-way communication, one round of communication helped to overcome some of the coordination problems, and three rounds of communication performed even better.

Wishes, expectations and actions: a survey on price formation in election stock markets

Abstract With error-prone and biased individual traders, can markets aggregate trader information and produce efficient outcomes? We review election stock market evidence that suggests this does happen. Individual traders appear biased and error-prone consistently, yet these markets prove quite efficient in predicting election outcomes. We also review work which documents comparable, but substantially different, phenomena in related laboratory markets. In addition, we report the results from a new laboratory session which shows how we can create particular biases that mirror those in election stock markets. Finally, we discuss how combined laboratory and field experiments can help us understand trader/market interactions.

Bank runs: Liquidity costs and investment distortions

Abstract In this paper we extend the Diamond and Dybvig (1983) model of intermediation to study further the conditions under which bank runs can occur and to consider how private parties might adjust to the existence of bank-run equilibria. We provide weaker necessary conditions for runs. We then characterize how banks respond to the possibility of runs in their design of deposit contracts and investment decisions. Banks might choose to offer contracts that prevent runs, but under some conditions the (second) best contracts will involve accepting some risk of runs in order to achieve higher expected returns from their investments.

The Economics of Public-Private Partnerships

Governments across Canada and around the world are looking for new ways to deliver public services at lower costs to taxpayers and users. Many have chosen to form public-private partnerships (P3s), involving the private sector to a much greater extent. This choice is often controversial, with the debates routinely driven by ideology more than careful analysis. This paper adds to the limited academic literature on P3s by reviewing the fundamental underlying economics of these relationships to get at their real costs and benefits. The goal is to help us better understand where and how P3s may be an efficient mechanism for the provision of public services.

Prices, Product Qualities and Asymmetric Information: The Competitive Case

Recent developments in the economics of information emphasize the informational content of prices. We examine the degree to which prices convey information on product quality to uninformed agents. Under perfect competition, we show that a rational expectations equilibrium may not exist. When an equilibrium does exist, the information on quality conveyed by prices depends on the shape of the average cost curves and the relative numbers of informed and uniformed agents.

CARTEL STABILITY AND PRODUCT DIFFERENTIATION

Abstract This paper employs a supergame-theoretic model of collusion to analyze the effects of different levels of product differentiation on cartel stability. In contrast to earlier work, the ability of the parties to reach an agreement is assumed. Here the focus is on how greater product homogeneity increases both the gain to cheating on a collusive agreement and the magnitude of the punishments that follow a defection. The total effect on the likelihood a cartel is stable is therefore unclear. Two particular differentiated products models are then used to demonstrate that, contrary to the conventional view, greater homogeneity can reduce cartel stability.

Strategic Alliances, Shared Facilities, and Entry Deterrence

We explore some possible anticompetitive effects of one particular type of strategic alliance--common in the airline industry, among others--that involves the sharing of production capacity. An offer to share an existing facility can allow an incumbent to persuade a potential entrant not to build its own facility. We establish conditions under which an agreement to share will be anticompetitive in the sense that, absent the agreement, a more competitive outcome (i.e., entry with new capacity) would have obtained. Such alliances can reduce welfare even if the incumbent and entrant will not be direct competitors.

Public-Private Partnerships and the Privatization of Financing: An Incomplete Contracts Approach

Governments have begun to embrace public-private partnerships (P3s) as vehicles for providing public services. This paper considers the controversial question of when private financing of public projects is optimal. Private development can dominate public financing through more efficient termination decisions for bad projects, resolving soft budget constraint problems. Due to contractual incompleteness and externalities, on the other hand, private developers cannot commit to large debt repayments, and hence can finance only a subset of valuable projects. Public developers, who do not face the same commitment problems, can finance a larger set of projects.

Forward induction in coordination games

Abstract This paper provides experimental evidence on the power of forward induction arguments in a 2×2 coordination game. Allowing one player the option of obtaining a certain payoff instead of playing the game coordinates play in the direction predicted by the forward induction argument. However, two-way pre-play communication is a more effective coordination device.