Discussion Paper Details

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Title: Optimal market design

Author(s): Jan Boone and Jacob K. Goeree

Publication Date: March 2010

Keyword(s): competition measures, competition policy, dynamic markets, mechanism design and Schumpeter

Programme Area(s): Industrial Organization

Abstract: This paper introduces three methodological advances to study the optimal design of static and dynamic markets. First, we apply a mechanism design approach to characterize all incentive-compatible market equilibria. Second, we conduct a normative analysis, i.e. we evaluate alternative competition and innovation policies from a welfare perspective. Third, we introduce a reliable way to measure competition in dynamic markets with non-linear pricing. We illustrate the usefulness of our approach in several ways. We reproduce the empirical finding that innovation levels are higher in markets with lower price-cost margins, yet such markets are not necessarily more competitive. Indeed, we prove the Schumpeterian conjecture that more dynamic markets characterized by higher levels of innovation should be less competitive. Furthermore, we demonstrate how our approach can be used to determine the optimal combination of market regulation and innovation policies such as R&D subsidies or a weakening of the patent system. Finally, we show that optimal markets are characterized by strictly positive price-cost margins.

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Bibliographic Reference

Boone, J and Goeree, J. 2010. 'Optimal market design'. London, Centre for Economic Policy Research.