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Too Much Waste: A Failure of Stochastic, Competitive Markets

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  • de Meza, David
  • Reito, Francesco

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.

Suggested Citation

  • de Meza, David & Reito, Francesco, 2016. "Too Much Waste: A Failure of Stochastic, Competitive Markets," MPRA Paper 76125, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:76125
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    References listed on IDEAS

    as
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    More about this item

    Keywords

    stochastic demand; rationing; waste; e¢ ciency.;
    All these keywords.

    JEL classification:

    • D61 - Microeconomics - - Welfare Economics - - - Allocative Efficiency; Cost-Benefit Analysis
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • H23 - Public Economics - - Taxation, Subsidies, and Revenue - - - Externalities; Redistributive Effects; Environmental Taxes and Subsidies

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