When does limited commitment matter in a production economy?

• Main Authors: CHOI, Kyoung Jin, LEE, Jungho
• Format: text
• Language: English
• Published: Institutional Knowledge at Singapore Management University 2018
• Subjects: Limited Commitment; Enforcement Constraints; First-best Allocation; Production Economy; Industrial Organization
• Online Access: https://ink.library.smu.edu.sg/soe_research/2058; https://ink.library.smu.edu.sg/context/soe_research/article/3057/viewcontent/sustainability20180528.pdf
• Institution: Singapore Management University

We investigate the conditions under which the first-best allocation without commitment is sustainable in a production economy. While it is widely known in the literature that allowing capital accumulation creates a distortion, we find that it can help to sustain the first-best allocation. We also find that for a certain set of endowment economiesin which the efficient allocation is not sustainable, the efficient allocation becomes sustainable once we introduce a production technology with very small returns to scale orany returns to scale higher than that of the minimum value. In some cases, gains fromefficient resource allocation between agents can be so large that they can compensate forthe increase in the outside option that arises when capital moves from the less-productiveto the more-productive agent.