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Income dispersion, asymmetric information and fluctuations in market efficiency

Author

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  • Chris Edmond

    (Economics, Stern School of Business New York University)

  • Laura Veldkamp

Abstract

Recessions appear to be times when markets function less efficiently. This phenomenon has been the domain of theories that rely on changes in preferences (demand shocks) or constraints on price-setting (sticky prices). In our simple model of decentralized trade with asymmetric information, income dispersion measures uncertainty about buyer characteristics. Counter-cyclical income dispersion makes the asymmetric information friction stronger in recessions: optimal prices rise and trade volume falls. Unlike preference changes or price-setting constraints, income dispersion is observable. Using income dispersion estimates to quantify the model's effect, we find that model prices, sales and markups have properties similar to business cycle data.

Suggested Citation

  • Chris Edmond & Laura Veldkamp, 2006. "Income dispersion, asymmetric information and fluctuations in market efficiency," 2006 Meeting Papers 717, Society for Economic Dynamics.
    • Handle: RePEc:red:sed006:717
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    Cited by:

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    3. Jaimovich, Nir & Floetotto, Max, 2008. "Firm dynamics, markup variations, and the business cycle," Journal of Monetary Economics, Elsevier, vol. 55(7), pages 1238-1252, October.
    4. Yilmaz, Ensar & Ünveren, Burak, 2011. "Income distribution and exchange in a dynamic search model," International Review of Economics & Finance, Elsevier, vol. 20(4), pages 665-678, October.

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    More about this item

    Keywords

    Income dispersion; information frictions; business cycles; prices; sales; markups;
    All these keywords.

    JEL classification:

    • E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles

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