Inefficiency in a Frictionless Market

10 Pages Posted: 5 May 2022 Last revised: 15 Aug 2022

See all articles by Keith Jin Deng Chan

Keith Jin Deng Chan

The Hong Kong University of Science and Technology

Date Written: January 30, 2022


Gale and Sabourian (2006) discuss the existence of inefficient Markov-perfect equilibrium (MPE) in a heterogeneous market. This paper shows that the example they provide cannot be supported as a MPE. Indeed, with two buyers and two sellers, the dispersion of bargaining positions is not sufficiently wide to support any inefficient trades in their setup. I then prove that their conjecture is correct by constructing a continuum of inefficient MPE with three buyers and three sellers, where the dynamics of continuation payoffs is rich enough to support wide dispersion of bargaining positions at the first stage, which in turn renders inefficient trades individually rational. This suggests that the number of players in a market could be essential for allocative inefficiency.

Keywords: Bargaining, markov-perfect equilibrium, random matching, allocative efficiency, frictionless

JEL Classification: C72, C78, D5

Suggested Citation

Chan, Keith Jin Deng, Inefficiency in a Frictionless Market (January 30, 2022). Available at SSRN: or

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