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The Economic Research Institute, Stockholm School of Economics SSE/EFI Working Paper Series in Economics and Finance

No 551:
Prices and quality signals

Mark Voorneveld () and Jörgen W. Weibull ()

Abstract: We consider a market-for-lemons model where the seller is a price setter, and, in addition to observing the price, the buyer receives a private noisy signal of the product's quality, such as when a prospective buyer looks at a car or house for sale, or when an employer interviews a job candidate. Sufficient conditions are given for the existence of perfect Bayesian equilibria, and we analyze equilibrium prices, trading probabilities and gains of trade. In particular, we identify separating equilibria with partial and full adverse selection as well as pooling equilibria. We also study the role of the buyer's signal precision, from being completely uninformative (as in standard adverse-selection models) to being completely informative (as under symmetric information). The robustness of results for these two boundary cases is analyzed, and comparisons are made with established models of monopoly and perfect competition.

Keywords: lemons; noisy quality signal; adverse selection; (follow links to similar papers)

JEL-Codes: C72; D82; (follow links to similar papers)

33 pages, February 12, 2004, Revised July 6, 2004

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