Efficient Non-Contractible Investments in Large Economies

Do investors making complementary investments face the correct incen­ tives, especially when they cannot contract with each other prior to their de­ cisions? We present a two-sided matching model in which buyers and sellers make investments prior to matching. Once matched, buyer and seller bar­ gain over the price, taking into account outside options. Efficient decisions can always be sustained in equilibrium. We characterize the inefficiencies that can arise in equilibrium, and show that equilibria will be constrained efficient. We also show that the degree of diversity in a large market has implications for the extent of any inefficiency. *This paper draws heavily from two earlier papers of ours, "Bargaining and Investment in a Two-Sided Matching Model" and "Efficient Non-Contractible Investments." We thank Daron Acemoglu, Jere Behrman, John Moore, Mark Rosenzweig, Randall Wright, a referee, an Associate Editor, and seminar audiences at numerous universities for helpful discussion and comments. The views expressed herein are those of the authors and not necessarily those of the Federal Reserve Bank of Minneapolis or the Federal Reserve System. tMailath and Postlewaite thank the Economics Department at the University of Bonn and the Minneapolis FRB for their hospitality. They also acknowledge financial support from the NSF, the Deutsche Forschungsgemeinschaft (SFB 303), and the Minneapolis FRB. Efficient Non-Contractible Investments in Large Economies by Harold L. Cole, George J. Mailath, and Andrew Postlewaite