Still the invisible hand by which markets smoothly and efficiently coordinate productive activity in economies looms large over economic theory. As this classical view holds, competition in markets provide economic agents with the correct opportunity cost as to induce socially efficient decisions by rational individual decision makers. As a corollary then markets solve the problem of allocating any given good as long as there exists a price for it.
However, in practice markets are prone to frictions. Numerous imperfections impede the flawless coordination of economic activity by markets and distort market prices. To name but a few examples, asymmetric information may prevent the formation of a market price, thus leading to a market breakdown (Akerlof, 1970). A lack of well-defined property rights may cause the invisible hand to stagger as externalities invalidate the first welfare theorem (Coase, 1960). Access to markets may depend on agents’ characteristics, thus neglecting some resources in the coordination process, the classical task of markets. To what extend is then a theoretical approximation of the world that relies on perfect markets meaningful?
The relevance of any theory hinges, of course, mainly on whether or not it is capable of providing adequate explanations for empirical facts. A brief glance at the empirical literature on the role of market imperfections might prove illuminating at this stage. Less developed countries are of primary concern as these economies are widely held to be affected particularly severely by market frictions that violate the assumptions of classical theory. Hence, they should be expected to be the first place to encounter large scale deviations from the predictions of classical theory.
Contents
1 Introduction
2 Galor and Zeira Go Gambling
2.1 Introduction
2.2 The Model
2.3 Preliminary Results
2.4 Lotteries and Intergenerational Dynamics
- 2.4.1 Sustainability
2.4.2 The Low Income Steady State
2.5 Welfare Analysis
2.6 Application
2.7 Conclusion
3 Inequality and Firm Size Distributions
3.1 Introduction
3.2 The Model
- 3.2.1 Agents
3.2.2 Assets
3.2.3 Coalitions and Ownership Structures
3.2.4 Sequence of Events
3.2.5 Contractual Environment and Renegotiations
3.2.6 The Matching Stage
3.2.7 Preferences over Ownership and Firm Size
3.2.8 Side Payments
3.2.9 Capital Market
3.2.10 Equilibrium Concept
3.2.11 Feasibility and Labor Demand
3.2.12 First Best Benchmark
3.3 Existence
3.4 Firm Size and Endowment Distribution
- 3.4.1 Properties of the Matching Equilibrium
3.4.2 Large Firms and Mean Preserving Spreads
3.4.3 Heterogeneity of Large Firms
3.4.4 The Income Distribution
3.5 Application
- 3.5.1 Bimodal Size Distributions
3.5.2 Inequality and Efficiency
3.5.3 Increasing Aggregate Endowments
3.6 Discussion and Conclusion
4 Markets and the Hold-up Problem
4.1 Introduction
4.2 The Framework
- 4.2.1 Agents
4.2.2 Coalitions
4.2.3 Matching Equilibrium
4.2.4 The Timing of Markets
4.2.5 A Numerical Example
4.3 Cost-sharing and Educational Attainment
- 4.3.1 Ex post Market
4.3.2 Ex ante Market
4.3.3 Discussion
4.3.4 Extensions
4.4 A Differentiable NTU Matching Setup
4.5 Attribute Investments
- 4.5.1 Constant Side Payments
4.5.2 Choosing the Utility Possibility Frontier
4.6 Conclusion
A Mathematical Appendix to Chapter
B Mathematical Appendix to Chapter 3
- B.1 Proofs
B.2 Numerical Examples
C Mathematical Appendix to Chapter 4
