A Laboratory Investigation of Networked Markets*

Department of Economics, University of California, Santa Cruz
The Economic Journal (Impact Factor: 1.95). 07/2006; 120(547). DOI: 10.1111/j.1468-0297.2009.02326.x

ABSTRACT When contracts are not perfectly enforceable, can interpersonal networks improve market e¢ ciency? We introduce exogenous networks into laboratory markets in which traders can cheat in "Distant" transactions but not in "Local" ones. Traders are anonymous outside their network, but inside it they can build a reputation. We examine network con…gurations that have the potential to completely overcome market failure and achieve competitive equilibrium (CE) e¢ ciency. Our results fall short of that mark, but the networks do signi…cantly reduce cheating and increase e¢ ciency. Moreover, the theoretical upper bounds correctly predict the main qualitative trade patterns across our four network architectures. The networks support increased international trade volume and reduced domestic volume, and divert transactions of the highest value and lowest cost units from domestic markets to international networks.

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Available from: Daniel Friedman, May 23, 2014
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