The Nature of Equilibrium in Markets with Adverse Selection
Volume: Volume 11, No. 1
Issue: Spring 1980
Pages: pp. 108-130
Authors: Charles Wilson
Title: The Nature of Equilibrium in Markets with Adverse Selection
Abstract: In the presence of adverse selection, how does the nature of the market equilibrium depend on the convention used to set the prices? Using a variant of Akerlof's model of the used car market, we examine the equilibrium of the model under three distinct conventions: (1) an auctioneer sets the price; (2) buyers set the price; (3) sellers set the price. Only in the case of the auctioneer is the equilibrium necessarily characterized by a single price which equates supply and demand. When either buyers or sellers set the price, a distribution of prices may emerge with excess supply at some or all of the prices. The analysis suggests that the allocation of goods in markets where adverse selection is a serious problem may be sensitive to the convention by which prices are set.
JEL Classification
Microeconomics Theory of Firm and Industry under Imperfectly Competitive Market Structures (0226)