Scandinavian Working Papers in Economics

SSE/EFI Working Paper Series in Economics and Finance,
Stockholm School of Economics

No 551: Prices and quality signals

Mark Voorneveld () and Jörgen W. Weibull ()
Additional contact information
Mark Voorneveld: Dept. of Economics, Stockholm School of Economics, Postal: Stockholm School of Economics, P.O. Box 6501, SE-113 83 Stockholm, Sweden
Jörgen W. Weibull: Department of Economics, Postal: Boston University, 270 Bay State Road, Boston, MA 02215, USA

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

JEL-codes: C72; D82

33 pages, First version: February 12, 2004. Revised: July 6, 2004. Earlier revisions: March 8, 2004.

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