Too Much Waste: A Failure of Stochastic, Competitive Markets

David de Meza and Francesco Reito

MPRA Paper from University Library of Munich, Germany

Abstract: The equilibrium of a competitive market in which firms must choose prices ex ante and demand is stochastic is shown to be second-best inefficient. Even under risk neutrality, equilibrium price exceeds the welfare-maximising predetermined price. Competition tends to eliminate rationing, but at the greater welfare cost of creating excess capacity. Entry incentives are also distorted. In low states, entrants obtain a share of revenue without increasing consumption, giving rise to a version of the common pool problem. In high states, firms do not appropriate the consumer surplus gained from marginal reductions in rationing. As a result of these o¤setting externalities, the number of firms may be excessive or insufficient. Inefficiency arises whether or not the rationing rule is efficient.

Keywords: stochastic demand; rationing; waste; e¢ ciency. (search for similar items in EconPapers)
JEL-codes: D61 D81 H23 (search for similar items in EconPapers)
Date: 2016-01-10
New Economics Papers: this item is included in nep-com and nep-mic
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