Market Microstructure and Informational Efficiency

The competitive market is informationally efficient; people only need to know prices to implement a competitive allocation. However, the standard formulation of competition neglects any underlying market microstructure; prices, which provide the necessary information, are exogenous. This paper studies the informational efficiency of two explicit market microstructures: search and market-makers. First, we prove that, compared to the competitive equilibrium, a large search economy requires an infinitely larger message space. Second, we prove that an economy with market-makers only needs one more dimension than the competitive process, making it second-best in terms of information but with an explicit model of decentralized price-formation.