Tulane University

This paper develops a new tractable strategic theory of counterfeiting as a competition between good and bad guys. There is free entry of bad guys, who choose whether and what note to counterfeit, and what quality to produce. Good guys select a costly verification effort. Along with the quality, this effort fixes the chance of finding counterfeits, and induces a collateral “hot potato ” passing game among good guys — seeking to avoid counterfeits passed around. We find a unique equilibrium of the entwined counterfeiting and verifying games. With log-concave verification costs, counterfeiters producer better quality at higher notes, but verifiers try sufficiently harder that the verification rate still rises. We prove that the unobserved counterfeiting rate is hill-shaped in the note, vanishing at extremes. We also deduce comparative statics in legal costs and the technology. We find that the very stochastic nature of counterfeiting limits its social cost. Our theory applies to fixed-value counterfeits, like checks, money orders, or money. Focusing on counterfeit money, we assemble a unique data set from th