The Theory and the Facts of How Markets Clear: Is Industrial Organization Valuable for Understanding Macroeconomics?

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This paper examines what industrial organization economists know and don't know about how markets clear. It reviews the empirical evidence which shows that, at least for some industries, price behavior is peculiar with prices failing to adjust over long periods of time. The paper discusses several existing theoretical explanations for the peculiar behavior such as fixed cost to changing price information asymmetries and theories of dynamic oligopoly. The paper goes on to develop some new theories to explain the observed behavior. The new explanations rely heavily on the importance of a seller's knowledge of his customers and on the optimality of non-price rationing. The paper discusses what relation, if anything, macroeconomics has to industrial organization.

Published: Schmalensee, Richard and Robery D. Willig (eds.) Handbook of Industrial Organization, Volume 1. Amsterdam: North-Holland, 1989.

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