By Yuet-Yee Wong and Randall Wright
We study bilateral exchange, both direct trade and indirect trade that happens through chains of intermediaries or middlemen. We develop a model of this activity and present applications. This illustrates how, and how many, intermediaries get involved, and how the terms of trade are determined. We show how bargaining with one intermediary depends on upcoming negotiations with downstream intermediaries, leading to holdup problems. We discuss the roles of buyers and sellers in bilateral exchanges, and how to interpret prices. We develop a particular bargaining solution and relate it to other solutions. In addition to contrasting our framework with other models of middlemen, we discuss the connection to different branches of search theory. We also illustrate how bubbles can emerge in intermediation.
We do not have good theories of middlemen. This is an interesting attempt at creating on that is based on search theory. Indeed, middlemen are good are overcoming (and exploiting) some frictions in markets, and search theory seems to be a natural place to start.