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Regulation through Reference Prices

Salgado Alfredo

No 2022-05, Working Papers from Banco de México

Abstract: This paper theoretically analyzes the role of reference prices on competition and welfare in a context of a circular city model with free entry and reference prices, in which paying market prices above a reference negatively affects the utility of consumers. Agents interact in a three-stage game: 1. A policymaker chooses a reference price to maximize consumer welfare. 2. Firms make their entry decision. 3. Firms compete in prices and consumers make their consumption decisions. We find that in equilibrium the market price and the optimal reference price chosen by the policymaker always coincide. In addition, it is shown that the use of reference prices reduces market equilibrium prices compared with the case without reference prices, which implies a net welfare gain for consumers. These gains could be higher in less competitive environments and lower in the presence of higher marginal costs.

Keywords: Regulation; Reference Prices; Welfare Gains (search for similar items in EconPapers)
JEL-codes: C7 D4 D9 L1 L2 L5 (search for similar items in EconPapers)
Date: 2022-03
New Economics Papers: this item is included in nep-com, nep-gth, nep-ind, nep-reg and nep-upt
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