Coexistence of Centralized and Decentralized Markets

Abstract

In this paper, I introduce a profit-maximizing centralized marketplace into a decentralized market with search frictions. Agents choose between the centralized marketplace and the decentralized bilateral trade. I characterize the optimal marketplace in this market choice game using a mechanism design approach. In the unique equilibrium, the centralized marketplace and the decentralized trade coexist. The profit of the marketplace decreases as the search frictions in the decentralized market are reduced. However, it is always higher than the half of the profit when the frictions are prohibitively high for decentralized trade. I also show that the ratio of the reduction in the profit depends only on the degree of search frictions and not on the distribution of valuations. The thickness of the centralized marketplace does not depend on the search frictions. I derive conditions under which, this equilibrium results in higher welfare than either institution on its own.