Economics Seminar（2014-01）

Topic: Unobservable Investment and Search Friction

Speaker: Yujing Xu

Affiliation:University of California

Time:Tuesday, 18 Feb. 15:30-17:00pm

Location:Room217, Guanghua Building 2

Abstract：

This paper studies investment incentives in a dynamic random search environment

where a supplier can make unobservable and sel sh investments to reduce his produc-

tion cost before searching for retailers. In the unique steady state equilibrium, suppliers

play mixed strategy over investments and retailers play mixed strategy over price of-

fers. Although suppliers make positive investments, suppliers' and retailers' equilibrium

payo s and the social welfare are a) constant given any search friction and b) equal to

the values that would be created if there were no investment. As search frictions di-

minish, the investment strategy converges in distribution to the rst best. In contrast,

the stationary investment distribution converges in distribution to a point mass at no

investment, resulting in severe trading ine ciency. The welfare loss due to the trading

ine ciency exactly o sets the e ciency gain from investments.

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