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Good and Bad Equilibria with the Informal Sector

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  • Bouwe R. Dijkstra
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    Abstract

    We examine whether an economy can have a bad (small or no formal sector, high taxes) as well as a good (small or no informal sector, low taxes) equilibrium. The government maximizes a combination of instantaneous welfare and the rate of decline of the informal sector. When the instantaneous welfare component only contains formal-sector welfare, multiple equilibria can occur if the elasticity of average to marginal cost for the public good is less than one. More regard for the informal sector leads to a worse equilibrium and to a higher prevalence of multiple equilibria.

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    Bibliographic Info

    Article provided by Mohr Siebeck, Tübingen in its journal Journal of Institutional and Theoretical Economics.

    Volume (Year): 167 (2011)
    Issue (Month): 4 (December)
    Pages: 668-685

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    Handle: RePEc:mhr:jinste:urn:sici:0932-4569(201112)167:4_668:gabewt_2.0.tx_2-b

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