competition model with a cost-reducing stage prior to the
price game and a settlement stage following it, we show that price deregulation entails decreasing
monitoring investments and increasing claims both in the short and long run. Even equilibrium
premiums may steadily increase if the “competition effect” connected to new entries is outweighed
by a “monitoring effect” that raises marginal costs.
KEYWORDS: motor insurance, settlement, costreducinginvestments, deregulation
∗We thank Luigi Buzzacchi, Don Hester, Patrick Legros, Emma Sarno, the Editor Ching-to Albert
, advertising expenditure and a
cost-reducinginvestment. We find the conditions for complementarities among scale, advertising
and innovation strategies to arise. In a duopoly with substitute products all variables are higher
for the firm that moves from mass advertising to targeted advertising but decrease for the other.
In an oligopoly with complementary products all variables are higher for all firms when they shift
away from mass marketing. We conclude by linking our results to the empirical literature on
internalization which finds a positive relationship between
. The paper studies the net effect of restructuring on retail prices
and cost-reducinginvestment and discusses policy implications.
JEL classification: D43, L43.
Keywords: Access pricing; investment; double marginalization; vertical fore-
closure; product differentiation.
It is widely believed that introducing competition is the key to achieving the
full benefits of privatization in previously monopolized and regulated
network industries, such as telecommunications, electricity or railways.1
The recent wave of ‘deregulation’ in these industries – i
(b) efficient firms face higher integration incentives. The driving force
are demand/mark-up complementarities in the product market. While this
observation is new in the context of vertical-integration decisions, similar
mechanisms have been exploited in other fields. For instance, Bagwell
and Staiger (1994) and Athey and Schmutzler (2001) use the related idea
that cost-reducinginvestments are strategic substitutes in the context of
many oligopoly models. Complementarities between demand-enhancing
and mark-up-increasing activities are crucial for this result.32
, 117: 55-77.
 Obara, I., (2001), “Private information in repeated games,” Ph. D. thesis.
University of Pennsylvania.
 Parreiras, S. (2005), “Correlated Information, mechanism design and in-
formational rents,” Journal of Economic Theory, 123:210-217.
 Persico, N., (2000), “Information acquisition in auctions,” Econometrica,
 Persico, N., (2004), “Committee design with endogenous information ”,
Review of Economic Studies, 71:165—191.
Obara: The Full Surplus Extraction Theorem with Hidden Actions
 Piccione, M and G. Tan, (1996), “Cost-reducing
balance of payments ad-
verse. So long as the incentive to invest is high because of cost-
reducinginvestment possibilities of the kind that Schumpeter
believed occurred at the bottom of a depression, more capital
is needed. With convertibility and joined capital markets, the
capital is provided from abroad. The maintenance of a single
capital market among the developed countries makes it impossi-
ble for European countries to hold back investment. Interest rates
that would rise at home because of reduced savings and a con-
stant or even higher inducement to
this showing, not higher, provided the pressures are kept on high
But the more usual tack is to suggest that the difficulty in
Britain has lain not so much with the level of demand but with
its instability. Investment is a function not of today's demand but
of tomorrow's. Before he undertakes cost-reducinginvestment
which expands capacity, the business executive needs assurance
that demand will be sustained. A project which would be under-
taken with a steady demand over 4 years might be abandoned
in favor of cash if there was a high probability of
opportunism. In other words,
unlike Table 5.1, Table 5.2 allows production costs to depend on orga-
nizational form. A "dynamic" effect occurs because the governance role
of the PTA encourages investment that changes the pattern of compara-
The first line of Table 5.2 reproduces the free-trade result in which
Country Three, the low-cost producer without cost-reducinginvestment
by Two, serves One's automobile market. In the second row of Table 5.2,
a one hundred percent nonpreferential tariff causes One to become inef-
ficiently self-sufficient in
the expense of its cost- reducinginvestment. even though its innovation would have been duplicative of that of the first, it
would have eroded that firm’s unilateral market power, which is the cause of reduced allocative
inefficiency. On the other hand, if the two firms each are able to elevate prices somewhat,
whether through coordination or through exercise of their own unilateral market power (which
the text suggests may or may not be possible), there may be sufficient reward to induce the
second innovator to proceed. Depending on the cost of the
., the strategic cost-
reducinginvestment is socially excessive at the margin if n > N(δ0).
An important question still remains. How large is the critical number
N(δ0) that appears in Theorem 23.1? In the case of concave inverse demand
functions, it is easy to see that N(δ0) = 2. In the case of constantly elastic
inverse demand functions,N(δ0)will increase as the elasticity η of the inverse
demand function increases, but for all values of η satisfying 0 < η < 1,
we have 1<N(δ0) < 2 +
2. Thus, N(δ0) remains fairly small for these
important classes of situations.