CeDEx Seminar - Paul Schaefer (University of Leicester)

The Effect of Social Relationships on Market Efficiency

This paper investigates the impact of social relationships on imperfectly competitive markets. I model social relationships as linear directed altruism in markets with substitutes and complements. The model predicts that social relationships among sellers of substitutes increase prices and reduce efficiency, and social relationships among sellers of complements do the reverse. I test these predictions in a controlled laboratory experiment, drawing on real-world friendships. The results confirm the model's key insights. I estimate a structural model where friends put a homogeneous profit weight of between 0.20 and 0.36 (95\% CI) on each other's profits.This weight can rationalize the effects of social relationships between substitutes and complements. Overall, the results suggest economists can analyze social relationships in imperfectly competitive markets similarly to other forms of profit internalization, such as common ownership and mergers.