Income dispersion, asymmetric information and fluctuations in market efficiency

Chris Edmond and Laura Veldkamp

No 717, 2006 Meeting Papers from Society for Economic Dynamics

Abstract: Recessions appear to be times when markets function less efficiently. This phenomenon has been the domain of theories that rely on changes in preferences (demand shocks) or constraints on price-setting (sticky prices). In our simple model of decentralized trade with asymmetric information, income dispersion measures uncertainty about buyer characteristics. Counter-cyclical income dispersion makes the asymmetric information friction stronger in recessions: optimal prices rise and trade volume falls. Unlike preference changes or price-setting constraints, income dispersion is observable. Using income dispersion estimates to quantify the model's effect, we find that model prices, sales and markups have properties similar to business cycle data.

Keywords: Income dispersion; information frictions; business cycles; prices; sales; markups (search for similar items in EconPapers)
JEL-codes: E3 (search for similar items in EconPapers)
Date: 2006
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Citations: View citations in EconPapers (5)

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Persistent link: https://EconPapers.repec.org/RePEc:red:sed006:717

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