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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, cost reducing investments, deregulation ∗We thank Luigi Buzzacchi, Don Hester, Patrick Legros, Emma Sarno, the Editor Ching-to Albert Ma

balance of payments ad- verse. So long as the incentive to invest is high because of cost- reducing investment 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 and long. 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-reducing investment 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- tive advantage. The first line of Table 5.2 reproduces the free-trade result in which Country Three, the low-cost producer without cost-reducing investment 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- reducing investment. 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- reducing investment 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. 23

. The Japanese empire, of course, was organized on a fundamentally different basis, and suggests that the term “reducing transactions costs” can be some- what euphemistic. Though Japan reduced transactions costs for Japanese ex- porters and investors, the government was clearly intent on raising them for everyone else through the imposition of formal and informal preferences. In developing the transactions costs approach, therefore, it is crucial to consider the extent to which the transactions cost-reducing investment is a private, club, or public good. The U

seller receives all the returns from any cost-saving actions. In contrast, under a cost-plus contract, the buyer pays all costs of production, thereby reduc- ing the incentives to the seller of making unobserved cost-reducing investments. If all events are foreseeable, then the fixed-price contract implements the first-best, whereas if events are unforeseeable, then the cost-plus contract is more efficient. Thus, if the costs of planning are sufficiently low that unforeseen events occur with low probability, then a fixed-price contract is optimal; the opposite holds

) and our article are complements. Second, he did not consider a case in which heterogeneous firms engage in R&D. Stenbacka (1991) considered the case in which the results of a cost-reducing investment are uncertain and the realization of the results is private information belonging to the innovating firm. He then examined whether merger anticipation leads to ex ante incentives for innovating firms to reveal their cost-reducing information. 5 Barros (1998) investigated a simple model highlighting the basic economic intuition about the relationship between initial