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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

, advertising expenditure and a cost-reducing investment. 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-reducing investment and discusses policy implications. JEL classification: D43, L43. Keywords: Access pricing; investment; double marginalization; vertical fore- closure; product differentiation. 1. INTRODUCTION 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-reducing investments 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. [33] Obara, I., (2001), “Private information in repeated games,” Ph. D. thesis. University of Pennsylvania. [34] Parreiras, S. (2005), “Correlated Information, mechanism design and in- formational rents,” Journal of Economic Theory, 123:210-217. [35] Persico, N., (2000), “Information acquisition in auctions,” Econometrica, 68:135-148. [36] Persico, N., (2004), “Committee design with endogenous information ”, Review of Economic Studies, 71:165—191. 25 Obara: The Full Surplus Extraction Theorem with Hidden Actions [37] 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- 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 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 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