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(De)Regulation and Market Thickness

Author

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  • Jean Guillaume Forand

    (Department of Economics, University of Waterloo)

  • Vikram Maheshri

    (Department of Economics, University of Houston)

Abstract

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.

Suggested Citation

  • Jean Guillaume Forand & Vikram Maheshri, 2012. "(De)Regulation and Market Thickness," Working Papers 1202, University of Waterloo, Department of Economics, revised Oct 2012.
  • Handle: RePEc:wat:wpaper:1202
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    References listed on IDEAS

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    More about this item

    JEL classification:

    • D04 - Microeconomics - - General - - - Microeconomic Policy: Formulation; Implementation; Evaluation
    • L51 - Industrial Organization - - Regulation and Industrial Policy - - - Economics of Regulation
    • C73 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Stochastic and Dynamic Games; Evolutionary Games
    • C78 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Bargaining Theory; Matching Theory

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