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Income Dispersion, Asymmetric Information and Fluctuations in Market Efficiency

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  • Laura Veldkamp
  • Chris Edmond

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.
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  • Laura Veldkamp & Chris Edmond, 2006. "Income Dispersion, Asymmetric Information and Fluctuations in Market Efficiency," Working Papers 06-13, New York University, Leonard N. Stern School of Business, Department of Economics.
  • Handle: RePEc:ste:nystbu:06-13
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    References listed on IDEAS

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    Cited by:

    1. YIlmaz, Ensar, 2011. "Income distribution, efficiency and rationing," Economic Modelling, Elsevier, vol. 28(3), pages 1247-1255, May.
    2. Antoniades, Alexis, 2015. "Heterogeneous Firms, Quality, and Trade," Journal of International Economics, Elsevier, vol. 95(2), pages 263-273.
    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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    JEL classification:

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

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