(De)Regulation and Market Thickness

Jean Guillaume Forand and Vikram Maheshri

No 1202, Working Papers from University of Waterloo, Department of Economics

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.

JEL-codes: C73 C78 D04 L51 (search for similar items in EconPapers)
Pages: 34 pages
Date: 2012-04, Revised 2012-10
New Economics Papers: this item is included in nep-dge and nep-mic
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Persistent link: https://EconPapers.repec.org/RePEc:wat:wpaper:1202

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