Working Paper: CEPR ID: DP1627
Authors: Raquel Fernandez; Jordi Galí
Abstract: We compare the performance of markets and tournaments as allocative mechanisms in an economy with borrowing constraints. The model consists of a continuum of individuals who differ in their initial wealth and ability level (e.g. students) and that are to be assigned to a continuum of investment opportunities or inputs of different productivity (e.g. schools of different qualities). With perfect capital markets both mechanisms achieve the efficient allocation, though markets generate higher aggregate consumption because of the waste associated with the production of signals under tournaments. When borrowing constraints are present, however, tournaments dominate markets in terms of aggregate output and, for sufficiently powerful signalling technologies, also in terms of aggregate consumption.
Keywords: markets; tournaments; matching; borrowing constraints
JEL Codes: D52; E44; J41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| tournaments (L83) | greater output (E23) |
| markets (G10) | equivalent aggregate output (E23) |
| tournaments (L83) | lower aggregate consumption (E21) |
| borrowing constraints (F34) | tournaments lead to greater output than markets (L13) |
| higher-ability individuals (D29) | better outcomes under tournaments (C72) |
| tournaments (L83) | enhanced effective allocation (D61) |
| signaling technologies (L96) | tournaments dominate markets in aggregate consumption (L83) |