Random Search in the Presence of Markets

This paper examines in a dynamic game-theoretic framework framework, the role of social institution of money and markets in facilitating exchange. It reveals how, depending on the level of transaction costs associated with a market setup (synonymously, trading posts) appropriate monetary trade emerges, which like a hub and spoke network (Starr and Stinchcombe, 1999) makes some markets non-functioning. However, despite the obvious advantages of a market setup in reducing search costs, pure random search for a complementary trading partner prevails in many economies, especially, in many developing economies. This paper models this feature of developing economies by introducing differences in transaction costs across agents and shows why sustainable equilibria might exist exhibiting random search for certain commodities even in the presence of established markets.