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Formal and informal markets: A strategic and evolutionary perspective

Author

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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.

Suggested Citation

  • Anbarci, Nejat & Gomis-Porqueras, Pedro & Marcus, Pivato, 2012. "Formal and informal markets: A strategic and evolutionary perspective," MPRA Paper 42513, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:42513
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    File URL: https://mpra.ub.uni-muenchen.de/42513/1/MPRA_paper_42513.pdf
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    References listed on IDEAS

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    1. D'Erasmo, Pablo N. & Moscoso Boedo, Hernan J., 2012. "Financial structure, informality and development," Journal of Monetary Economics, Elsevier, vol. 59(3), pages 286-302.
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    More about this item

    Keywords

    informal markets; bilateral bargaining; directed search; taxation;

    JEL classification:

    • C78 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Bargaining Theory; Matching Theory
    • E26 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Informal Economy; Underground Economy

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