Efficiency and marginal cost pricing in dynamic competitive markets with friction

This paper examines market models with supply friction. We examine a competitive equilibrium model, and a monopolistic model in which a single firm determines the market price. The following conclusions are obtained: (i) If friction is present, no matter how small, then the market prices fluctuate between zero and the “choke-up” price, without any tendency to converge to the marginal production cost, exhibiting considerable volatility. This conclusion holds for both the competitive equilibrium market model, and the monopolistic market model. (ii) The long-run average price in the competitive model is always greater than the marginal cost, but less than the long-run average cost in the monopolistic model. (iii) In the competitive model the consumer obtains social surplus, while in the monopolistic model the supplier extracts the entire surplus from the market.