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Topics in industrial organization.

Topics in Industrial Organization

The NBER held a conference on "Topics in Industrial Organization" in Cambridge on July 31 and August 1. NBER researchers Paul L. Joskow and Nancy L. Rose, both of MIT, organized the following program:

Severin Borenstein, University of Michigan, "Price

Discrimination in Retail Gasoline Markets"

Discussant: Andrea L. Shepard, MIT

Ann F. Friedlaender, MIT, "Efficient Rail Rates and


Discussant: John R. Meyer, Harvard University

Michael A. Salinger, Columbia University, "A Test of

Successive Monopoly and Foreclosure Effects:

Vertical Integration between Cable Systems and

Pay Service"

Discussant: Paul L. Joskow

Scott E. Masten and Edward A. Snyder, University of

Michigan, and James W. Meehan, Jr., Colby

College, "The Cost of Organization"

Discussant: Ingo Volgelsang, Boston University

Randal R. Rucker, North Carolina State University,

and Keith B. Leffler, University of Washington,

"Transaction Costs and Efficient Organization of

Production: A Study of Timber Harvesting"

Discussant: R. Glenn Hubbard, NBER and Columbia


William P. Rogerson, Northwestern University,

"Profit Regulation of Defense Contractors and Prizes

for Innovation" (This paper is summarized in

"Studies of Firms and Industries" in this issue.)

Discussant: Michael D. Whinston, NBER and Harvard


James Blumstein, Vanderbilt University; Randall

Bovbjerg, Urban Institute; and Frank A. Sloan,

NBER and Vanderbilt University, "Valuing Life and

Limb in Tort: A Common Law of Damages and

Insurance Contracts for Future Services"

Discussant: Joseph P. Newhouse, Harvard University

Michael Moore and W. Kip Viscusi, Duke University,

"The Effect of Product Liability on Innovation"

Discussant: Roger G. Noll, Stanford University

Ralph Winter, University of Toronto, "The Dynamics

of Competitive Insurance Markets"

Discussant: J. David Cummins, University of


Why is the retail margin on regular unleaded gasoline consistently higher than the retail margin on regular leaded gasoline? The average difference grew from less than one cent in 1979 to more than five cents in 1986 but since has fallen to about two-and-a-half cents in 1989. Borenstein finds that cost-based explanations --focusing on differences in inventory costs, average size of purchases, or use of credit cards--explain little, if any, of the levels or changes in margin differences. Using a panel of gasoline prices in 57 SMSAs from 1984 to 1989, Borenstein finds price discrimination based on heterogeneity in buyers' costs of switching sellers. As the average income of buyers of leaded gas has fallen relative to the average income of buyers of unleaded gas, the margin difference has widened. After 1986, many stations stopped selling leaded gas--increasing the relative switching costs of buyers of leaded gas--and the margin on leaded gas has risen relative to the margin on unleaded gas. Changes in relative incomes explain a small proportion of the changes in margin differences. But the decline in the availability of leaded gasoline explains between one-quater and one-half of the change in margin of differences since 1986.

Are "fair" rates to captive shippers compatible with "fair" rates of return for the railroads in the period of quasi-deregulation since 1980? To answer this, Friedlaender develops a model in which a public utility faces a breakeven constraint while selling in two sectors: a competitive one, in which price equals marginal cost, and a captive one, which has to bear the entire revenue burden. The markup in the captive sector depends on the degree of economies of scale and on the marginal-cost revenue shares in the captive and competitive sectors. Using the results of a cost function based on panel data of Class I railroads from 1974-86, Friedlaender shows that under reasonable assumptions concerning the appropriate measure of economies of scale, the two goals are not incompatible in the long run. Thus, the relevant policy question is not whether reregulation should be instituted but how to devise appropriate policies to move from the current situation, marked by a high degree of scale economies, to a long-run equilibrium marked by moderate scale economies.

Salinger compares the prices charged, and the services offered, by vertically integrated and unintegrated cable systems to test for successive monopoly and foreclosure effects. He finds that integrated cable systems are less likely to offer at least three pay channels, and somewhat less likely to offer four pay channels, than unintegrated systems are, but there is no significant difference in the prices charged for pay services by integrated and unintegrated systems.

Masten, Snyder, and Meehan suggest ways of overcoming difficulties inherent in direct tests of economic theories of organization. Specifically, they discuss problems in testing transaction-cost arguments and identify parallels to familiar selection and censoring problems. They then apply these methods to a sample of components from a large naval construction project. The data permit them to: 1) test the relationship between attributes of the transaction and the costs of organizing, both within and between firms; and 2) provide dollar estimates of those costs.

Rucker and Leffler examine the choice of selling privately owned standing timber by lump sum or per unit. Empirical results, obtained by using primary data on individual private timber sales contracts, support the predictions of a transaction cost model and reject several predictions from a risk-based model of contract choice.

Blumstein, Bovbjerg, and Sloan describe two possible reforms to our tort system: the first is a reporting system to record current damage awards that would have precedent value. Future jury awards in the middle half of the expected distribution would be presumptively valid, and more extreme findings would have to be justified explicitly. This approach would allow the law on appropriateness of damages to progress in common-law, monitored fashion rather than on the traditional ad hoc basis. The second proposal is a method of "structuring" damages for future medical care and other services to injured claimants. It would pay for future services not in cash (whether as a traditional lump sum at settlement or through newer annuity-like periodic payments), but instead by funding an actual service contract for necessary care.

The substantial rise in product liability costs has altered the financial incentives for innovation greatly. Higher liability costs increase the incentive to improve product safety and discourage firms from introducing new high-risk products. At very high levels of liability, firms will abandon innovation and focus on no-risk products, typically those characterized by generally accepted technologies. Moore and Viscusi use two large datasets for 1980-4. They match data from the PIMS survey on R and D, patents, and new product introductions with detailed information on insurance premiums and losses from the Insurance Services Office. They find that product liability has a nonlinear effect on innovation. At low liability levels, increases in liability costs increase measures of innovation, but this influence becomes negative at extremely high levels of innovation. The effects are stronger for product innovation than for process innovation, which is consistent with the greater importance of liability for design defects, as compared with manufacturing defects. The findings are robust across a variety of liability cost measures and are replicated using other data on R and D.

In the conventional economic treatment of insurance pricing, premiums equal the expected present value of claims. Winter offers an alternative, dynamic model of insurance markets based on two assumptions: first, risks are dependent because of common factors in the distribution of losses. This assumption, together with limited liability of insurers, implies that the industry stock of net worth or equity limits the amount of insurance that can be offered credibly at any time. Second, there is a cost advantage to internal capital over external equity in raising financing. An insurance cycle, or persistence of the gap between premiums and the present value of claims, results. Tight markets or "crises" of high premiums and profits are caused by depletion of capacity (net worth) through bad draws on the common factors. Crises persist because insurers rationally prefer to wait out the rapid accumulation of retained earnings rather than to resort to costly external capital. Soft markets arise from the accumulation of retained earnings and persist because of the chance that the excess stock of internal equity will be needed in the future. In tight markets, gains to trade disappear in the riskiest times when there is dependence in the events of losses. In the context of liability insurance, this dependence is attributed to uncertain liability standards in tort law. Nonlinear pricing, such as coverage limits, arises because of dependence or common factors in the size of losses (for example, uncertain tort awards).

Also attending the conference were: Geoffrey Carliner, NBER; Richard E. Caves, Harvard University; Frank M. Gollop, Boston College; Zvi Griliches, NBER and Harvard University; Scott E. Harrington, University of South Carolina; Oliver D. Hart, Garth Saloner, and Jean Tirole, MIT; Alvin E. Klevorick, Richard C. Levin, and Ariel Pakes, NBER and Yale University; B. Peter Pashigian, University of Chicago; Robin A. Prager, Vanderbilt University; Peter C. Reiss, NBER and Stanford University; Michael H. Riordan, Boston University; and Carl Shapiro, NBER and Princeton University.
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Title Annotation:conference
Publication:NBER Reporter
Date:Sep 22, 1989
Previous Article:Studies of firms and industries.
Next Article:European economic integration.

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