(De)Regulation and Market Thickness
In this paper, we develop a general view of regulation as a set of constraints imposed on market transactions by a welfare-maximizing authority. We present a novel frictional search model with horizontal differentiation and nontransferable utility in which a regulator determines the set of permitted match-specific production functions. Once the dynamic market opens, buyers and sellers are matched and sellers propose transactions from among those that are allowed. We show the existence and uniqueness of a marketequilibrium for any choice of regulatory constraints and characterize the regulator’s exante optimal choice of regulatory environment. We argue that in less developed, or ‘thin’, markets, regulation is an important tool to correct market failure arising from mismatch between buyers and sellers. However, if markets develop and become ‘thick’, regulations can become onerous vestiges and deregulation is welfare-enhancing. In this case, a regulator can rely on market participants’ equilibrium behavior instead of explicit constraints on economic activities to ensure that transactions occur efficiently.
|Date of creation:||Apr 2012|
|Date of revision:||Oct 2012|
|Contact details of provider:|| Postal: Waterloo, Ontario, N2L 3G1|
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