SFB 303 Discussion Paper No. A - 198

Author: Wildasin, David E.
Title: Market Failure in a Credit-Rationed Economy
Abstract: This paper studies a simple two-period general equilibrium model of a competitive economy with endogenous "Type one" credit rationing. It is shown that an equilibrium will generally not be efficient, in the absence of corrective policies. The nature of the market failure, and of optimal government policy, is then examined. Underinvestment in individual firms can be corrected by interest subsidies or similar instruments, while taxes are needed to penalize excessive levels of default that would otherwise occur in equilibrium. These policies are interpretable in the spirit of Pigovian taxes and subsidies.
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Creation-Date: July 1988
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