Waterloo economics series | 1995

Abstracts of working papers

#9510 -- Robert R. Kerton and Richard W. Bodell

Quality, choice and the economics of concealment the marketing of lemons (PDF)


The quantity of hazardous or ineffective products on national and international markets is higher than can be explained by current theory. Research has shown that "lemons" can indeed occur and it has specified roles for (a) potential future purchases and (b) seller reputation. This paper explores incentives facing sellers of goods containing one or more negative characteristics. The economics of concealment provides the conditions under which some sellers use resources to interfere with quality signals. This allows, at the extreme, a class of product which is a "pure lemon" in that its very existence would not be justified if consumers were fully informed. The paper identifies important variables which have direct policy implications for regulation and for consumer welfare.

# 9509 -- Stanley W. Kardasz and Kenneth R. Stollery

International competitiveness and price formation in Canadian manufacturing industries


This paper examines the responsiveness of the prices of domestic and imported goods in the domestic market to changes in the costs of both goods. Using time-series data for a broad sample of Canadian manufacturing industries, it is found that domestic cost changes have small price effects in industries where domestic producers are internationally cost competitive, concentration is low and import shares are high, whereas import cost changes have large price effects in industries with these characteristics.

# 9508 -- Robert A. Amano and Tony S. Wirjanto

Intertemporal substitutions, imports and the permanent-income


We examine the importance of intertemporal substitution in U.S. import consumption using a model of permanent income that allows for random preference shocks and additive separability. The latter feature allows us to take two estimation approaches. In the first approach, we show that there is a cointegrating restriction imposed by the first-order conditions of the model. Given the assumed preference specification, this restriction leads to a linear cointegrating relation between imports consumption, domestic goods consumption and their relative price that is supported by the data. Using this restriction to recover the preference parameters, we estimate the intertemporal elasticity of imports and domestic goods consumption. In the second approach, we estimate the Euler equations using generalized method of moments. For this estimation procedure to be valid, however, we must place some restrictive assumptions on the model that are not required for the first estimation approach. Thus, the two different approaches allow us to assess the severity of these assumptions often imposed in the literature.

Journal of Economic Literature (JEL) classification

F10, E21, C22


Intertemporal elasticity of substitution; imports; consumption; cointegration; generalized method of moments

# 9507 -- Wai-Ming Ho

Imperfect information, money, and economic growth


This paper develops an endogenous growth model with financial market imperfections in order to study the effects of money on economic growth and to examine the role of informational imperfections in the determination of the equilibrium growth path. It is found that the economy grows slower when there is imperfect information. Changes in money growth have qualitatively similar effects on the economies with and without private information. However, the economy with private information will be less responsive to monetary shocks. This latter result contradicts the popular view that informational imperfections in credit markets or borrowing constraints tend to amplify the impact of policy intervention.

# 9506 -- James R. Melvin

Services in an information economy

# 9505 -- James R. Melvin

History and measurement in the service sector: a review


The three books reviewed are:
Economic Council of Canada, Employment in the Service Sector, Minister of Supply and Services, Canada: Ottawa, 1991.
Delaunay, Jean-Claude, and Jean Gadrey, Services in Economic Thought: Three Centuries of Debate, Kluwer Academic Publishers: Boston, 1991.
Griliches, Zvi (ed), Output Measurement in the Service Sectors, NBER Studies in Income and Wealth, Vol. 56, University of Chicago Press: Chicago, 1992.

# 9504 -- David Andolfatto and Glenn M. MacDonald

Endogenous Technological change, growth, and aggregate fluctuations


The paper develops a model of the economy in which the development and spread of technological innovations is endogenous. Production and learning activities on the part of competitive firms interact with housefold decisions to generate growth and fluctuations in aggregate economic activity. The model's structural parameters are estimated by maximum likelihood; the extent to which such a framework can be used to interpret macroeconomic data is assessed.

# 9503 -- David Andolfatto and Glenn M. MacDonald

Technological innovation, diffusion, and business cycle dynamics


In the U.S. economy, real output growth is forecastable with its own lag and the lagged consumption--output ratio. With technological progress modeled as a random walk, standard real-business-cycle (RBC) models fail to replicate this fact: these models generate equilibrium output dynamics that largely inherit the properties of the assumed impulse dynamics, leading some researchers to question the empirical relevance of technology shocks for generating business cycle dynamics.
In this paper, we develop a model economy that exhibits endogenous stochastic growth with aggregate fluctuations driven by technology shocks that are absorbed with some lag, reflecting the costly and time--consuming nature of innovation and diffusion. Our purpose is to compare the resulting business cycle dynamics with those predicted by standard RBC models, which implicitly assume the instantaneous diffusion of new technology. Unlike the standard RBC model, the environment studied here generates business cycle dynamics that better resemble observed patterns.

# 9502 -- David Andolfatto and Paul Gomme

Unemployment insurance, labour market dynamics, and social welfare


This paper investigates the economic effects and social desirability of various publicly administered unemployment insurance programs in the context of a dynamic general equilibrium model of labor market search. Individuals in the economy are subject to two types of idiosyncratic disturbances: one shock alters the productivity of the current job opportunity, affecting the worker's wage, while the other shock alters the productivity of the home technology, affecting the worker's value of leisure. At any date, individuals must choose whether or not to participate in the labor market. Those who do participate either exploit their current job opportunity or abandon it --- hence becoming unemployed --- in search of potentially better opportunities elsewhere. The positive analysis focuses on how program changes in the unemployment insurance system affect labor market flows between states of employment, unemployment and nonparticipation, as well how these changes affect the economy's natural rate of unemployment. The normative analysis evaluates the extent to which publicly administered unemployment insurance can improve social welfare by completing missing private insurance markets.

# 9501 -- Walter Bossert

Choices, consequences, and rationality


A generalized theory of revealed preference is formulated for choice situations where the consequences of choices from given menus are uncertain. In a nonprobabilistic framework, rational choice behavior can be defined by requiring the existence of a preference relation on the set of possible consequences and an extension rule for this relation to the power set of the set of consequences such that the chosen sets of possible outcomes are the best elements in the feasible set according to this extension rule. Rational choice is characterized under various assumptions on the properties of these relations.

JEL classification

D11, D81


Rational choice, uncertainty, extension rules