Too Much Waste: A Failure of Stochastic, Competitive Markets

de Meza, David and Reito, Francesco (2016): Too Much Waste: A Failure of Stochastic, Competitive Markets.

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.

• Item Type: MPRA Paper
• Language: English
• Keywords: stochastic demand, rationing, waste, e¢ ciency.
• Subjects: D - Microeconomics > D6 - Welfare Economics > D61 - Allocative Efficiency ; Cost-Benefit Analysis; D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D81 - Criteria for Decision-Making under Risk and Uncertainty; H - Public Economics > H2 - Taxation, Subsidies, and Revenue > H23 - Externalities ; Redistributive Effects ; Environmental Taxes and Subsidies

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