Inflation and Welfare in Retail Markets: Prior Production and Imperfectly Directed Search

Abstract

This paper considers the effect of monetary policy and inflation on retail markets: goods are dated and produced prior to being retailed; buyers direct their search on price and general quality; buyers' match-specific tastes are private information. Sellers set the same price for all buyers, some of whom do not value the good highly enough to buy it. The market economy is typically inefficient as a social planner would have the good consumed. Under free entry of sellers, the Friedman rule is optimal policy. When the upper bound on the number of participating sellers binds, moderate levels of inflation can be welfare improving.JEL codes: D82, E40 a discussion of how the alternative market structures considered in RW affects outcomes in this environment.

Capacity Choice, Monetary Trade, and the Cost of Inflation

“…We see our work as complementary to those papers. The innovations in Dutu and Julien (2008) and Masters (2013) differ in focus from ours: Dutu and Julien (2008) consider the question of equilibrium existence in a competitive search model with indivisible money, while Masters (2013) focuses on the interaction between inflation and private information about product quality. Of particular relevance for our analysis are the insights in Anbarci et al (2019) and Lebeau (2019), who show that Nash bargaining in economies with ex ante production can lead to stark unraveling results.…”

“…Finally, there are only a few papers in the literature that, like ours, incorporate an ex ante production choice into a monetary search model, in contrast to the majority of the literature that has assumed production on demand. 1 Notable contributions incorporating ex ante production into monetary search include Dutu and Julien (2008), Masters (2013), Anbarci et al (2019), and Lebeau (2019). We see our work as complementary to those papers.…”

Competitive Cooperation

“…It shows that mixed Nash equilibrium converges to degenerate pure strategy equilibria which involves over-investment from both sides of the market. Furthermore, Masters [18] focus on monetary implications such as inflation and welfare effect of the prior production. Aside from the similar inefficient conclusions, he also verifies the validity of Friedman rule and suggest a moderate level of inflation.…”

On the Timing of Production Decisions in Monetary Economies

“…Jafarey and Masters (2003) and Dutu and Julien (2008), use searchtheoretic models of the second generation with indivisible money as in Shi (1995) and Trejos and Wright (1995), which limits their applicability. Production in advance was recently studied by Masters (2013) in a model of (imperfectly) directed search with divisible money where buyers'preferences are match-speci…c and private information. He shows in particular that, when the upper bound on the number of participating sellers binds, moderate levels of in ‡ation can increase welfare by making buyers less choosy.…”

“…The strategic interaction we highlight, which is central to the non-optimality of the Friedman rule, comes from the random matching and bargaining with prior production environment that we use. Masters (2013) works with a price posting model where sellers, even though they produce ahead of the market, can post complete contracts. Having worked out a price posting version of our model, we …nd no role for strategic interaction in such environment, and then no role for in ‡ation.…”