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Formal and informal markets: A strategic and evolutionary perspective

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  • Anbarci, Nejat
  • Gomis-Porqueras, Pedro
  • Marcus, Pivato

Abstract

We investigate the coexistence of formal and informal markets. In formal markets, we assume sellers can publicly advertise their prices and locations, whereas in informal markets, sellers need to trade through bilateral bargaining so as to remain anonymous from the taxing authority. We consider two models. As a benchmark, we first only allow sellers to switch between markets, which enables us to derive some analytical results that show the existence of a stable equilibrium where formal and informal markets coexist. We also establish that some sellers will migrate from the formal market to the informal market if the formal market's advantage in quality assurance erodes, or the government imposes higher taxes and regulations in the formal market, or the risk of crime and/or confiscation decreases in the informal market, or the number of buyers in the informal market increases. Some sellers will migrate from the informal market to the formal market whenever the opposite changes occur. We then allow both sellers and buyers to switch between markets. In this model, we illustrate that if the net costs of trading for sellers in the formal sector and buyers in the informal sector have opposite signs, then there is a unique locally stable equilibrium where formal and informal markets coexist.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 42513.

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Date of creation: 07 Nov 2012
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Handle: RePEc:pra:mprapa:42513

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Keywords: informal markets; bilateral bargaining; directed search; taxation;

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  1. Kyle Bagwell, 2005. "The Economic Analysis of Advertising," Discussion Papers 0506-01, Columbia University, Department of Economics.
  2. Camera, Gabriele & Delacroix, Alain, 2003. "Trade Mechanism Selection in Markets with Frictions," Purdue University Economics Working Papers 1166, Purdue University, Department of Economics.
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  14. Erwan Quintin, 2008. "Contract enforcement and the size of the informal economy," Economic Theory, Springer, vol. 37(3), pages 395-416, December.
  15. Kenneth Burdett & Shouyong Shi & Randall Wright, 2001. "Pricing and Matching with Frictions," Journal of Political Economy, University of Chicago Press, vol. 109(5), pages 1060-1085, October.
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