Formal and informal markets: A strategic and evolutionary perspective

Nejat Anbarci (), Pedro Gomis-Porqueras and Marcus Pivato

MPRA Paper from University Library of Munich, Germany

Abstract: We investigate the coexistence of formal and informal markets. In formal markets, we assume sellers can publicly advertise their prices and locations, whereas in informal markets, sellers need to trade through bilateral bargaining so as to remain anonymous from the taxing authority. We consider two models. As a benchmark, we first only allow sellers to switch between markets, which enables us to derive some analytical results that show the existence of a stable equilibrium where formal and informal markets coexist. We also establish that some sellers will migrate from the formal market to the informal market if the formal market's advantage in quality assurance erodes, or the government imposes higher taxes and regulations in the formal market, or the risk of crime and/or confiscation decreases in the informal market, or the number of buyers in the informal market increases. Some sellers will migrate from the informal market to the formal market whenever the opposite changes occur. We then allow both sellers and buyers to switch between markets. In this model, we illustrate that if the net costs of trading for sellers in the formal sector and buyers in the informal sector have opposite signs, then there is a unique locally stable equilibrium where formal and informal markets coexist.

Keywords: informal markets; bilateral bargaining; directed search; taxation (search for similar items in EconPapers)
JEL-codes: C78 E26 (search for similar items in EconPapers)
Date: 2012-11-07
New Economics Papers: this item is included in nep-gth and nep-iue
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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