Top PDF Firm behaviour in markets with capacity constraints

Firm behaviour in markets with capacity constraints

Firm behaviour in markets with capacity constraints

Abstract I study firms’ behaviour in markets where firms’ long-run capacity decisions, made in the presence of uncertain demand, constrains short-run competition. In Chapter 2, I analyse firms’ investment and pricing incentives in a differentiated products framework with un- certain demand. Firms choose production capacities before observing demand and choose prices after demand is realised. Unlike previous models, when firms are identical, symmet- ric pure-strategy equilibria exist, even in the presence of very low capacity costs. Further- more, industry capacity in these symmetric equilibria is strictly greater than the equivalent Cournot equilibrium industry capacity for low costs, and equal to the Cournot industry capacity for higher costs. Subsidies on capacity costs have a greater positive impact on equilibrium capacity than an equivalent subsidy on production costs. In Chapter 3, I use this model to analyse how the market changes when firms practice ‘withholding’. This is when firms withdraw capacity from the market in the short-run, after demand is realised, in the hope of making greater profits. I show that withholding is an optimal strategy for firms in these markets, and that compared to the no-withholding case, equilibrium output is lower in low demand states and higher in high demand states. Equilibrium capacity strictly increases. I discuss why it is hard to find real world examples of withholding in action, despite the increased profits. Chapter 4 looks at the specific case of the electricity industry. Electricity markets are a good example where capacity constraints and random demand affect competitive outcomes. However, trade in electricity is subject to additional constraints caused by the transmission of electricity through a network. Network constraints are well understood to cause considerable non-convexities in firms’ optimisation problems;
Show more

91 Read more

Firm Behaviour in Markets with Capacity Constraints

Firm Behaviour in Markets with Capacity Constraints

these capacity choices influence short-run competition. Since Edgeworth’s modification of Bertrand’s price game, economists have studied how capacity constraints can change the nature of short-run competition. These studies have tended to remain theoretical in nature. The seminal 1983 work of Kreps and Scheinkman [12] founded a literature of what I call ‘capacity-price’ models. These models are based on two- stage games, games where firms choose capacity at stage one, then price at stage two after all firms observe capacity choices. The work of Kreps and Scheinkman was extended to different rationing rules (Davidson and Deneckere [5]), uncertain demand in the short-run (Reynolds and Wilson [14]), and to the differentiated products setting (Friedman [8]). However, most of this work has remained fixedly theoretical, for good reason. Under Kreps and Scheinkman’s standard assumptions, pure-strategy equilibria only exist under particular conditions, such as assuming the efficient rationing rule. This limits the use of comparative statics in any possible applications. 1 Furthermore, in this literature, only Reynolds and Wilson tackle the issue of uncertain demand, which is at the heart of the economic dilemma outlined above. In the specific case of electricity, theory is even more problematic, as electricity markets are not only subject to capacity constraints on the production of electricity, but also to capacity constraints on its transmission. This abundance of non-linear network constraints has seen economists turn away from theory in favour of economic experiments. Such work is relatively new, but promising: economic experiments avoid the intractability that bedev- ils theoreticians. However, current experiments are usually limited to three or four node networks; hardly a good approximation of, say, the California electricity grid.
Show more

91 Read more

A MODEL OF FIRM BEHAVIOUR WITH EQUITY CONSTRAINTS AND BANKRUPTCY COSTS.

A MODEL OF FIRM BEHAVIOUR WITH EQUITY CONSTRAINTS AND BANKRUPTCY COSTS.

f . 26 5. Synthesis of Results The first model analysed above, where firms have limited access to the equity market but not to the debt market, is characterised by rather straightforward results. Both lower levels of current cash flow from existing operations and higher uncertainty over output prices lead to lower levels of production and investment. These variables do not affect investment when financial markets are perfect, but play an important role in this context of imperfect financial markets due to their impact on the expected marginal bankruptcy cost. In turn, a decrease in the banks’ required return leads to an increase in production and investment; in this case, two channels operate: the ‘conventional’ impact on the standard user cost of capital and the impact on the marginal bankruptcy cost, which reinforces the ‘conventional’ effect. 27
Show more

28 Read more

Joint Bidding under Capacity Constraints

Joint Bidding under Capacity Constraints

More surprisingly, there are some special markets con- figurations for which we find bid shading, but not dif- ferential bid shading. In our 2 × 2 × 2 case (two units, two firms and two plants each) there exists a symmetric equilibrium in which all the plants bid according to the same bidding function. More precisely, they bid as in a symmetric equilibrium for this auction format with three bidders that can win up to one unit. Of course, this func- tion lies everywhere above the symmetric equilibrium bidding function for the case with disperse ownership, and this implies that the expected price is higher, but not as much as it would with three independent plants. Sym- metry and monotonicity guarantee efficient outcomes.
Show more

13 Read more

Unobserved Capacity Constraints and Entry Deterrence

Unobserved Capacity Constraints and Entry Deterrence

The fully informative separating equilibrium can be sustained, specifically, when the constrained incumbent faces relatively lower expansion costs than the unconstrained firm. This difference in expansion costs might arise if, for instance, financial institutions discriminate constrained and unconstrained incumbents, charging different financial costs to each type. In this case, only the separating equilibrium arises where, as suggested above, entry patterns coincide with those under complete information, and no policy intervention is needed. In other contexts, both types of firm might face relatively similar expansion costs, illustrating situations where financial markets are not capable of differentiating constrained and unconstrained incumbents, thus charging both types of incumbent similar financial costs. In this setting, our paper shows that government intervention might be welfare improving under certain conditions, even when the regulator is uninformed about the incumbent’s cost structure. In particular, we demonstrate that a policy reducing the financial costs associated with expansion induces a change in the equilibrium outcome from a pooling to a separating equilibrium. 3 We also predict that, despite the potential benefits from lowering financial costs —inducing similar entry patterns as under complete information— such policy can be easily overdone, which occurs when expansion costs are reduced beyond certain levels. In particular, under extremely low expansion costs, both types of incumbent expand their facilities, changing the equilibrium prediction, from a pooling equilibrium where no type of incumbent expands to one where both types expand. However, entry patterns coincide in the pooling equilibrium with and without expansion.
Show more

44 Read more

Financing constraints and firm dynamics

Financing constraints and firm dynamics

ciently high and since the two factors of productions are complementary, variable capital is too high as well. 2) Both irreversibility of fixed capital and financing constraints. As in the previous case, it will take some time to adjust the stock of fixed capital. During the adjustment period expected profits drop and the expected rate of wealth accumulation drops as well with respect to a situation where fixed capital is reversible. As a result the entrepreneur has a higher chance to face future financing constraints: i) if the contraction period is long enough, then the drop in wealth can be so severe that she does not have enough funds to invest in variable capital; ii) if the contraction period ends, she will have not enough resources to invest in both fixed and variable capital and will be financially constrained for some time. In order to compensate these higher costs of future expected financing constraints, the entrepreneur engages in precautionary saving ex ante, more th an it would have done with reversible capital. However since fixed capital cannot be reduced, such precautionary saving behaviour affects variable capital only. Therefore the combination of higher current and future expected financing constraints implies that variable capital becomes much more volatile with respect to the case without irreversibility of fixed capital, and drops more in response to the permanent decrease in productivity.
Show more

179 Read more

Financial Constraints and Firm Dynamics

Financial Constraints and Firm Dynamics

None of the proposed approaches are without their pitfalls, and there is no clear consensus on how different ways of measuring FCs can impact the obtained results. On the one hand, both uni- variate or multivariate proxies derived from business registers inevitably give an indirect measure of FCs, as they implicitly assume that the poor records of firms with respect to the chosen variables get translated into a bank’s unwillingness to grant credit. This assumption appears particularly problem- atic when the analysis is exclusively based on totally exogenous variables, like age, or structural and extremely persistent variables, like availability of collateral. On the other hand survey based mea- sures, which are seemingly closer to answering the question as to whether a firm has actually been constrained or not, are well known to suffer from misreporting and sample selection bias, whose ef- fect is difficult to quantify. Moreover, by collecting the opinion of the credit seeker about their own financing conditions, survey data look at the demand side of credit relations. Rather, given the strong informational asymmetries characterizing capital markets, it is the opinion of the credit supplier on the credit seeker that plays the crucial role in determining credit conditions.
Show more

34 Read more

Bidding markets with financial constraints

Bidding markets with financial constraints

ceptable bids increases with the working capital. This feature is present in a number of settings in which firms have limited access to external financial resources. One example is an auction in which the price must be paid upfront, and hence the maximum acceptable bid increases with the firm’s working capital. Another example is a procurement contest in which the firm must be able to finance the difference between its working capital and the cost of production. Because of this financing needs, the less the firm’s working capital is, the larger its minimum acceptable bid must be if the external funds that are available to the firm increase with its bid or its profitability. The latter property arises when the spon- sor pays in advance a fraction of the price, 9 a feature of the common practice of progress payments, or when the amount banks are willing to lend depends on the profitability of the project as it is usually the case. 10
Show more

44 Read more

Capacity Management:  Intra-Firm and Inter-Firm Perspectives.

Capacity Management: Intra-Firm and Inter-Firm Perspectives.

capacity. In Chapter IV, we also build game-theoretic models where firms share a common supplier and examine how the relationship between the two firms affects the capacity investment decisions, when the demand is random, the capacity is deterministic, and the capacity investment cost is linear in the invested capacity size. In some cases, the firms are not directly competing in the market, for example, when they serve two geographically separated markets. In other cases, firms may directly compete against each other such as in a Cournot market. In these two market structures, demands for both firms are independent and positively-correlated respectively. For a given market structure, firms first choose the capacity types: to share (first-priority) or not to share (exclusivity). Then they build capacity at the supplier contingent upon the capacity types, and finally serve the market. Our analysis shows that even if choosing the first- priority is Pareto-optimal for both firms, buying firms tend to choose the exclusive capacity, driven by the incentive of capacity cost and the possibility to drive the other firm to build excess capacity. This provides a parsimonious explanation about the widely observed exclusive claim attached to the capacity investment to the supplier, as well as the managerial insights that doing so may trap the buying firms in a prisoner’s dilemma. Interestingly, we also observe that a free-rider equilibrium can be sustained, where one firm chooses the first-priority capacity, builds a larger capacity, and allows the other firm with the exclusive capacity to free-ride on its invested capacity. This, in general, is driven by the capacity cost. These free-rider and prisoner’s dilemma equilibria are observed in the independent market, but not in the Cournot market.
Show more

210 Read more

Financial Constraints and Firm Export Behavior

Financial Constraints and Firm Export Behavior

We find strong evidence that less credit constrained firms self-select into export markets or, from a complementary point of view, that external funds are an important determinant of firm export status. In fact, export starters display better financial health than their non exporting competitors even before starting to operate abroad. On the contrary, the hypothesis that internationalization leads to better access to financial markets finds very limited support. In truth, firms heavily engaged in export activities appear to enjoy better financial health in the year after entry into foreign markets, but this phenomenon is short- lived and not particularly robust. Consistently with our previous findings, we observe that access to external financial resources is an important but not crucial determinant of the probability to start exporting. We find no evidence of a positive relationship between fi- nancial health and commitment to international trade. Conversely, higher export intensity is associated with lower financial health. This result is only apparently paradoxical since it corroborates the idea that the relevance of financial constraints is due to the presence of sunk entry costs. Since higher export intensity can be regarded as a proxy for the number of foreign markets served by a firm (Mayer and Ottaviano, 2007), exporting a higher share of production entails facing higher sunk entry costs (assuming that at least part of them are destination-specific), which drives down financial health.
Show more

37 Read more

Bankruptcy, Finance Constraints and the Value of the Firm

Bankruptcy, Finance Constraints and the Value of the Firm

The rest of the paper is organized as follows. The primitives of the economy are laid out in Section I. The investment and portfolio choices of firms and consumers are described in Section II, together with their possible decisions in the process of renegotiation of firms’ debt and, if that fails and default occurs, in the liquidation of the firms’ assets. Competitive equilibria are then defined and some properties of consumers’ and firms’ choices determined. This allows us to obtain a simpler (reduced form) set of equilibrium conditions that is used in the rest of the analysis. After showing that an equilibrium always exists, Section III characterizes the parameter values for which equilibria are efficient or inefficient. The properties of these equilibria are analyzed in more detail in Section IV, where we illustrate the consequences of the binding finance constraint. Here we also show that inefficient sunspot equilibria may exist, with fluctuations in asset prices leading to financial crises. Finally, in Section V, we show that efficiency can be restored by introducing new markets or using tax-transfer schemes. Some of the proofs are relegated to the appendix.
Show more

35 Read more

Horizontal Mergers in the Presence of Capacity Constraints

Horizontal Mergers in the Presence of Capacity Constraints

1. Introduction A commonly held view among economists is that, in the absence of efficiency gains, horizontal mergers between oligopolistic firms raise prices. 1 But recent works by Froeb, et al. (2003) and Higgins, et al. (2004) challenge this view. In particular, Froeb, et al. (2003) conduct numerical simulations of a merger model with price competition among capacity-constrained firms, and they find that “[i]n the case where the merged firm is capacity-constrained, there is no merger price effect.” To be more specific, they show that, although the capacity constraints on the non-merging firms drive up post-merger prices as has long been believed, the capacity constraints on the merging firms depress post-merger prices, and the latter effect is greater than the former. When both merging firms are capacity constrained, a merger has simply zero effect on price, quantity, consumer surplus and total welfare. Extending the approach of Froeb, et al.
Show more

28 Read more

Water Markets in Mexico: Opportunities and Constraints

Water Markets in Mexico: Opportunities and Constraints

This district is divided into 17 modules which are irrigated by the Río Nazas, and 3 more modules irrigated by the Río Aguanaval. Major crops are cotton, alfalfa, beans, sorghum, walnuts, and maize. Recent trends show an increase in the cultivation of higher valued crops such as melons, grapes, alfalfa, and watermelons. 18 Water to irrigate this district comes from the Lazaro Cardenas Dam, with a capacity of 2,779 MCM, and the Francisco Zarco Dam, with a storage capacity of 368 MCM. Annual surface flows from these sources averaged 1,348 MCM for the four years prior to the 1995-96 drought. 19 There are also over 2,500 tubewells in the irrigation district and additional tubewells to supply water for residential and industrial uses. Total withdrawals of groundwater are estimated at 600 MCM per year.
Show more

27 Read more

The dynamics of bidding markets with financial constraints

The dynamics of bidding markets with financial constraints

The intuition behind the proposition is based on our results in the static model. There, we use the property that the game has the all pay auction structure: after deleting strictly dominated strategies, the firm that carries more working capital wins but carrying working capital is costly for both firms. This argument also applies here because this property is inherited from one period to the previous one in the following sense: if the payoffs of the reduced game in period t satisfy the property, so do the payoffs of the reduced game in period t − 1. To see why, note that the usual result of all pay auctions that bidders without competitive advantage get their outside opportunity implies here that the laggard’s equilibrium payoffs in the reduced game of period t are equal to the payoffs of consuming all its cash and starting period t + 1 as a laggard with cash m. The leader’s equilibrium payoffs in the reduced game in period t have an additive premium which is a consequence of the leader’s ability to carry sufficient working capital to undercut any acceptable bid of the laggard. This ability is independent of the amount of cash the leader has and so it is the premium. Consequently, the value of a marginal increase in the cash with which the firm starts period t is equal to its consumption value plus the value of switching from laggard to leader. The value of switching from laggard to leader is zero because a marginal increase in cash switches the leadership only when the cash is common and no less than θ (by (14) and Assumption 1) so that the premium is zero because none of the firms is constrained by cash to bid above cost. We can thus conclude that, in period t − 1, a unit increase in working capital, keeping constant the bid, is costly in the sense that it reduces the current consumption in one unit but only increases the future utility in its discounted value β. This means, as in the static model, that it is not profitable to carry more working capital than necessary to make the bid acceptable. Thus, in period t − 1, after deleting strictly dominated strategies, the firm that carries more working capital wins but carrying working capital is costly for both firms. 39
Show more

57 Read more

Competition in a Democratic Firm System: Failures and Constraints

Competition in a Democratic Firm System: Failures and Constraints

This refers us back to the question if Marx and Engels opposed markets to the point of discouraging their retention even during the transition to communism. Engels believed that the true focus point of volume one of Capital was not ca- pitalism proper, but just a pre-capitalistic commodity production method. In fact, this view is proved wrong by the Introduction to the Grundrisse , where we read that following a review of Hegel’s Logic Marx dropped his initial plan to commence his exposition with a description of commodities production in a pre-capitalistic society and resolved to start with an analysis of capitalism. This was made clear by Bidet in a comparative analysis of the Grundrisse and Capital , which showed that the distinction between a market economy and a capitalistic system emerged much more clearly from the former than the latter. And al- though this did not justify any direct conclusions about the role of markets in a post-capitalist economy, he concluded, it doubtless rendered “the prospect of basing socialism on the abolition of the market less self-evident” [40]; see, also, [41]. In fact, nowhere did Marx or Engels ever claim that the instant abolition of markets was a necessary precondition for the success of a revolution.
Show more

17 Read more

Financial constraints in China: firm-level evidence

Financial constraints in China: firm-level evidence

As expected, we find the coefficient on total liabilities to assets to be negative (and highly significant) only for private companies, meaning that high existing liabilities reduces the firm’s capacity to invest. This confirms our earlier results in Table 2 i.e. that private Chinese firms are credit constrained. The results on the indebtedness of private firms contrast strongly with those on other type of firms where the debt ratio does not affect the public companies’ and foreign companies’ investment. For the SOE firms in China we interpret this as evidence in support of the notion of a soft budget constraints (Qian and Roland, 1998) where irrespective of their indebtedness, state-owned firms still find the financial means outside the firm to engage in investment. For foreign firms, the irrelevance of firm-level indebtedness for investment purposes may be related to intra-group financial means at their disposal.
Show more

30 Read more

Financial constraints in China: firm-level evidence.

Financial constraints in China: firm-level evidence.

As expected, we find the coefficient on total liabilities to assets to be negative (and highly significant) only for private companies, meaning that high existing liabilities reduces the firm’s capacity to invest. This confirms our earlier results in Table 2 i.e. that private Chinese firms are credit constrained. The results on the indebtedness of private firms contrast strongly with those on other type of firms where the debt ratio does not affect the public companies’ and foreign companies’ investment. For the SOE firms in China we interpret this as evidence in support of the notion of a soft budget constraints (Qian and Roland, 1998) where irrespective of their indebtedness, state-owned firms still find the financial means outside the firm to engage in investment. For foreign firms, the irrelevance of firm-level indebtedness for investment purposes may be related to intra-group financial means at their disposal.
Show more

26 Read more

Firm Growth and Liquidity Constraints: A Dynamic Analysis

Firm Growth and Liquidity Constraints: A Dynamic Analysis

EU countries for different size classes of firms. He also concludes that higher growth-cash flow sensitivities are a sign of bigger finance problems and that growth-cash flow sensitivity of SMEs are broadly similar across EU countries. Their empirical work supports survey results suggest- ing that finance constraints tend to hinder the growth of small and very small firms; on average, the growth of these firms is one-to-one related to internal funds, notably retained profits. They also find that growth-cash flow sensitivities are higher for unquoted firms than for quoted firms. Based on Hall (1987) and Evans (1987a, 1987b) firm growth specifications, Elston (2002) developed an alternative model which controls other factors related to growth including liquidity constraints measured by cash flow. 5 Elston (2002) finds that cash flow, after con- trolling for size and age, positively affects growth of German Neuer-Markt firms. On the other hand, Audretsch and Elston (2002) show that medium-sized German firms are more liquidity constrained (in their investment behaviour) than either the smallest or the largest ones. Contrary to Carpenter and Petersen’s (2002) model, this specification is better suited to being applied to a sample of unquoted firms because we cannot use the Tobin’s q that captures the investment opportunities. Following Elston (2002), Fagiolo and Luzzi (2004) also analyse whether liquidity constraints faced by business firms affect the dynamics of firm size and growth. Considering a balanced panel data set of manufacturing Italian firms over the period 1995–2000 they estimated firm growth specifications by pooled OLS, suit- ably expanded to take liquidity constraints into account. Finally, Hutchinson and Xavier (2004) make a quantitative exploration to investigate how the quantity of internal finance constrains the growth of SMEs across the entire manufac- turing sector of a leading transition country, Slovenia, and an established market economy, Belgium. They find that firms in Slovenia are more sensitive to internal finance constraints than their Belgian counterparts. This suggests that Slovenian firms are no longer recipients of soft budget constraints, capital markets are not yet functioning properly.
Show more

18 Read more

Capacity Markets for Electricity

Capacity Markets for Electricity

the pool was deficient for some days in June, July and August 2000 - owners of capacity increased their exports for periods during which external prices exceeded the PJM price and therefore de-listed their resources from the PJM. In particular, on June 1, the total demand for daily capacity credits exceeded the sum of capacity net of planned outages and the pool was deficient by 334 MW. On June 2, the daily price was $174/MW-day, and on June 3, it rose to $177 (close to the binding CDR in 2000) and it remained at that level for the rest of the month. After investigation, the MMU reported that the opportunity costs of selling into the PJM market (defined as “the additional revenue foregone from not selling into an external energy and/or capacity market”) appear to explain the level of supply available to the daily capacity credit markets, de-listing and imports by capacity owners and thus the shape of the supply function and the ultimate market price. The high levels of mandatory bids, that is the capacity deficiency charge, contributed to the observed level of market prices. After reviewing key measures of market structure and performance (net revenue, price-cost mark-up index, concentration and prices), the MMU concluded that the energy market in 2000 was “reasonably competitive”, with no systematic exercise of market power, although “the evidence is not dispositive” (PJM, 2001a). In particular, the highest prices in the PJM real-time spot market occurred in December ($802/MWh), while the next higher prices occurred during an early heat spell in May.
Show more

32 Read more

Collateral constraints and rental markets

Collateral constraints and rental markets

Abstract We study a benchmark model with collateral constraints and heterogeneous discounting. Contrarily to a rich literature on borrowing limits, we allow for rental markets. By incorporating this missing market, we show that impa- tient agents choose to rent rather than to own the collateral in the neighbor- hood of the deterministic steady state. Consequently, impatient agents are not indebted and borrowing constraints play no role in local dynamics.

14 Read more

Show all 10000 documents...