Waterloo economics series | 2002

Abstracts of working papers

#02-01 -- Anindya Sen

Higher prices at the gas pump: international crude oil price fluctuations or local market concentration? An empirical investigation forthcoming in energy economics.


There is little consensus on whether higher retail gasoline prices in Canada are the result of international crude oil price fluctuations or local market power exercised by large vertically-integrated firms. I find that although both increasing local market concentration and higher average monthly wholesale prices are positively and significantly associated with higher retail prices, wholesale prices are more important than local market concentration. Similarly, crude oil prices are more important than the number of local wholesalers in determining wholesale prices. These results suggest that movements in gasoline prices are largely the result of input price fluctuations rather than local market structure.

#02-02 -- Anindya Sen

Does protecting smaller firms result in lower prices? Evidence from Canadian gasoline markets

(under review)


Some recent policy initiatives aimed at preserving the market share of smaller gasoline retailers have been proposed in Canada. These measures are grounded in the belief that strengthening such firms will enhance competition and result in lower prices, which is consistent with the implications of the dominant firm/competitive fringe model. Using monthly data on average retail prices and market shares across eleven Canadian cities between 1991 and 1997, I find the opposite to be true. Specifically, increased market concentration on the part of independent retailers is in fact, significantly correlated with higher retail prices. This may be due to an enhanced ability to set prices as well as higher marginal costs of production experienced by these retailers, relative to corresponding costs incurred by larger and more efficient vertically integrated firms.

#02-03 -- Anindya Sen

To encourage or not to encourage seat belt use: simultaneity bias and offsetting behaviour (PDF)

(with Brent Mizzen, Department of Finance, Government of Canada) (Published in the Canadian public policy)


Estimating the efficacy of seat belt use is important as compensating risk-taking or "offsetting behaviour" by drivers may attenuate benefits from vehicle safety regulation. However, evidence on partial-offsetting behaviour from previous studies may simply reflect simultaneity bias, as increasing deaths from traffic accidents results in tougher policies aimed at encouraging seat belt use. We find significant evidence of such measurement error. Ordinary Least Squares (OLS) estimates from Canadian provincial data between 1980 and 1996 imply partial offsetting behaviour as increased average seat belt use over the sample period resulted in a 13.42% decline in vehicle occupant fatalities, in contrast to the expected 39-46% drop. However, corresponding instrumental variables (IV) estimates imply a lack of significant risk compensation as increased seat belt use is associated with a 37% fall in occupant deaths.

#02-04 -- Anindya Sen

Does increased abortion lead to reduced crime? Evaluating the relationship between crime, abortion, and fertility

(under review)


Donohue and Levitt (2001) attribute over half the current decline in U.S. crime rates to the legalization of abortion. I contribute to the literature by using provincial Canadian data, which permits the segregation of trends in teenage abortions from general abortion rates. This distinction is important, as I find that a much larger drop in violent crime (almost half) during the nineteen-nineties, is attributable to the increase in teenage abortions due to abortion legalization. In contrast, the fall in general abortion rates accounts for a quarter of the decline. Hence, falling crime rates are largely attributable to abortion legalization resulting in better timing of births, rather than lower cohort size. Further, I find that the drop in teenage fertility rates during the nineteen-sixties and seventies, accounts for the entire fall in violent crime. This is probably in part, due to the increase in contraception sophistication (the pill) witnessed during that era.

#02-05 -- Anindya Sen

Do Stricter Penalties or Media Publicity Reduce Alcohol Consumption By Drivers?

(under review)


Most research using cross-country data find income elasticities with respect to health expenditure equal to or exceeding unity. These results might be confounded due to omitted variables bias as well the presence of unobserved country and year specific determinants of per capita health expenditures. Empirical results from fifteen Organization for Economic Co-operation and Development (OECD) countries between 1990 and 1998 support these hypotheses. Specifically, OLS coefficient estimates drop by roughly more than 50% with the use of two way fixed effects models and the inclusion of various demand and supply based determinants of per capita health expenditures.

#02-07 -- John Burbidge

Tax deferred savings plans (PDF)


Governments around the world operate personal income tax systems but most governments go to considerable lengths to mitigate the distortions caused by the interest tax component of the income tax. A popular antidote is the tax deferred savings plan (TDSP), (e.g., RRSP in Canada or 401(k) in the U.S.; see Poterba (1994a)). It is thought that by deferring income taxes on saving, and the interest income on savings, such plans will move the income tax system closer to the more efficient consumption tax. I argue that whether or not TDSPs in fact move income tax systems away from or closer to a consumption tax depends on whether or not interest on debts incurred to make TDSP contributions is deductible for income tax purposes. If people optimize as assumed in simple life-cycle models then it may be that governments can convert a nonlinear income tax system to a proportional consumption tax system by permitting unlimited TDSPs and disallowing the deductibility of debt interest.

#02-08 -- Margaret Insley

On the option to invest in pollution control under a regime of tradable emissions allowances

Forthcoming in the Canadian journal of economics


This paper analyses the optimal decision of a firm faced with the option of retrofitting its plant to reduce pollution and thereby eliminate the need to purchase emissions allowances. The decision is treated as a real option with the price of pollution permits assumed to follow a known stochastic process. The model is formulated as a set of one-dimensional partial differential equations. At discrete points in time, the firm owner is assumed to make optimal decisions about the retrofitting. In addition, if mothballing is allowed, the owner can halt the installation, with the option of resuming at later date. Optimality conditions are imposed at each decision date, which link the set of one-dimensional partial differential equations. The model is used to calculate critical permit prices at which the firm should choose to retrofit.

Journal of Economic Literature (JEL) classification


#02-09 -- Margaret Insley

Real options in harvesting decision on publicly owned forest lands (PDF)

(with K. Rollins, University of Nevada) (under review)


This paper extends the literature on optimal tree harvesting assuming stochastic prices. With volatile prices, the value of a stand of trees is increased when harvesting dates are flexible, depending on wood volume and product prices of the day. Flexibility adds value because a forest owner can delay harvesting when prices are depressed, or can harvest earlier than planned if there is a uptick in prices. The stand owner thus has a natural hedge against price volatility. Regulatory policy in some jurisdictions has reduced the flexibility of firms harvesting on public lands by imposing allowable cut restrictions. This paper develops a two factor real options model of the harvesting decision over infinite rotations with mean reverting stochastic prices. The model is used to examine a proposed investment in intensive forest management in Ontario's boreal forests. The value of a representative stand in the Romeo Malette forest is estimated assuming complete harvesting flexibility. This value is then compared to the value when regulations dictate a window of time during which harvesting must occur.