Background
Incomplete markets are those where certain goods or services lack an organized market on which they can be traded. This lack of tradeability impedes resource allocation and economic efficiency, often leading to market failures.
Historical Context
The concept of incomplete markets gained significant attention with the development of general equilibrium theory in the mid-20th century. Economists like Kenneth Arrow and Gérard Debreu highlighted the importance of complete markets for the optimal allocation of resources. The inability to trade certain assets or risks due to market incompleteness can undermine these idealized models.
Definitions and Concepts
Incomplete markets refer to situations where:
- Certain Goods or Services Cannot Be Traded: There may be no platform or marketplace for the transaction of some goods or services.
- Non-We’vented Goods: Some goods or services are so novel that no market exists for them yet.
- Complexity in Contracts: Some contracts may be so intricate that the cost of legalizing and enforcing them outweighs the benefits.
- Lack of Demand: There may be too few participants interested in trading specific goods, making the establishment of a market infeasible.
Incomplete markets are a classic source of market failure, where markets fail to allocate resources efficiently.
Major Analytical Frameworks
Classical Economics
Classical economists did not distinguish explicitly between complete and incomplete markets. However, market deficiencies like monopoly and lack of competition were recognized as impediments to effective resource distribution.
Neoclassical Economics
Focuses on perfect competition and market equilibrium concepts. In this framework, incomplete markets represent a deviation from the ideal competitive marketplace, causing inefficiencies.
Keynesian Economics
Emphasizes aggregate demand and state intervention. Incomplete markets may justify policy interventions to correct inefficiencies and stabilize the economy.
Marxian Economics
Views incomplete markets as failures within a capitalist framework, where the inability to trade certain assets perpetuates systemic inequalities and inefficiencies.
Institutional Economics
Examines the role of institutions and legal structures in either exacerbating or mitigating the effects of incomplete markets. Institutional reforms can help rectify these inefficiencies.
Behavioral Economics
Explores how cognitive biases and bounded rationality contribute to market incompleteness. Markets may be incomplete because individuals do not recognize or exploit potential trade opportunities.
Post-Keynesian Economics
Focuses on uncertainty and the role of financial markets. Incomplete markets can create financial instability and necessitate active economic policies to maintain stability.
Austrian Economics
Criticizes government intervention and advocates for spontaneous market order. Austrian economists may see incomplete markets as opportunities for entrepreneurial discovery rather than systemic failure.
Development Economics
Identifies the prevalence of incomplete markets in developing economies. Addressing these, often through financial inclusion and institutional development, is central to fostering economic growth.
Monetarism
Examines how money, banking, and monetary policy interface with incomplete markets. Dead assets or untapped resources often highlight market incompleteness.
Comparative Analysis
Incomplete markets are often analyzed compared to complete markets. Real-world markets seldom reach complete equilibrium, and the existence of incomplete markets illustrates the gap between economic theory and practice. Various economic schools highlight different causes and remedies for these market failures.
Case Studies
Explorative case studies may revolve around specific incomplete markets—such as markets for new technologies, complex financial derivatives, or niche agricultural products. For instance, the difficulty of insuring rare, catastrophic events shows how market incompleteness can impact risk transference and financial stability.
Suggested Books for Further Studies
- Incomplete Markets by Jean O. Lanjouw and James M. Snyder
- Transaction Cost Economics: Past, Present, and Future by Oliver E. Williamson
- General Equilibrium Theory: An Introduction by Ross M. Starr
Related Terms with Definitions
Arrow–Debreu Economy: A model of a complete market in which there exists a market for every conceivable good and asset, used to gauge the efficiency of resource allocation.
Coase Theorem: A principle that under certain conditions, when property rights are specified and transaction costs are negligible, private negotiations will lead to efficient outcomes regardless of initial allocation.
Market Failure: A situation where the allocation of goods and services is not efficient, often due to incomplete markets, externalities, or other distortions.
