We find conditions under which private agents bribe bureaucrats, while they do not bribe each other. An equilibrium with corruption and an equilibrium without corruption can co-exist. The equilibrium without corruption has higher social welfare and supports a larger bureaucracy than the equilibrium with corruption. Despite the socially inefficient corruption it may generate, a bureaucracy can improve welfare through its inflexibility. We study the coexistence of monetary and credit transactions in a model where exchange is decentralized.
Agents belong to different villages which are informationally separated.
The frequency of meetings between any two different villages decreases in their geographic distance. The equilibrium mix of monetary and credit transactions is characterized as a function of the frequency of meetings among agents from different villages. Our economy may be interpreted as a medieval economy. Trade takes place only among a small set of nearby villages via the use of credit. Monetary trades emerge only after interactions with faraway villages become sufficiently frequent.