Econometrica: Sep, 1994, Volume 62, Issue 5

Convergence to Efficiency in a Simple Market with Incomplete Information

https://doi.org/0012-9682(199409)62:5<1041:CTEIAS>2.0.CO;2-W
p. 1041-1063

Aldo Rustichini, Mark A. Satterthwaite, Steven R. Williams

A model of trade with $m$ buyers and $m$ sellers is considered in which price is set to equate revealed demand and supply. In a Bayesian Nash equilibrium, each trader acts not as a price-taker, but instead misrepresents his true demand/supply to influence price in his favor. This causes inefficiency. We show that in any equilibrium the amount by which a trader misreports is $O(1/m)$ and the corresponding inefficiency is $O(1/m^2)$. The indeterminacy and the inefficiency that is caused by the traders' bargaining behavior in small markets thus rapidly vanishes as the market increases in size.