An Economic Theory, Second Edition
Chapter 9: Speculative Intermediation and the Role of Inventory Management
9.1 FAILURE OF RECONTRACTING In Chapter 6 recontracting was identiﬁed as one of the important characteristics of perfect competition. Recontracting means that buyers and sellers continue negotiating until their plans have been completely harmonized, and only then does trade proceed. However, negotiation takes time, and it is unreasonable to assume that the economy can remain in suspended animation following a disturbance until all trading plans have been renegotiated. If trading continues after the disturbance and before renegotiation can be completed, then disequilibrium will ensue. Transactors on one side or other of the market will face quantity rationing; either buyers will be unable to purchase as much as they demand or sellers will be unable to dispose of all their supplies. Transactors’ inability to fulﬁl trading plans in one market will force them to modify their plans in other markets. Indeed, because a rational individual formulates an integrated trading plan covering all markets, failure to fulﬁl the plan in one market is likely to have repurcussions in all other markets in which he is involved. The consequences of continuing to trade without renegotiation are perfectly foreseeable. It is to be expected that an entrepreneurial response will be forthcoming. The obvious response is for a market-making ﬁrm to hold an inventory of the good in order to buffer ﬂuctuations in demand and supply. An exogenous increase in demand, or a reduction in supply, is accommodated by running down the inventory. A reduction in demand or an increase in supply...
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