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Adverse selection and the economic limits of market substitution: An application to e-commerce and traditional trade in used cars

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  • Fabel, Oliver
  • Lehmann, Erik E.

Abstract

Adverse selection induces economic limits to market substitution. If quality uncertainty persists in both internet and traditional marketplaces, a second-best equilibrium with parallel market segments may arise. Positive trade in parallel segments implies that the information cost advantage of one marketplace is exactly offset by a more severe adverse selection problem associated with non-observable quality variables. The electronic marketplace providing dominant search means contains all segments, while the traditional market may lack some segments. These missing segments are characterized by low quality expectations given the vector of advertised quality signals. The analytic results are confirmed by an empirical investigation of used-car trade. Thus, the study also provides an estimate of the price differential between the electronic and the traditional marketplace.

Suggested Citation

  • Fabel, Oliver & Lehmann, Erik E., 2000. "Adverse selection and the economic limits of market substitution: An application to e-commerce and traditional trade in used cars," Discussion Papers, Series I 302, University of Konstanz, Department of Economics.
  • Handle: RePEc:zbw:kondp1:302
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    References listed on IDEAS

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    Cited by:

    1. Anindya Ghose, 2005. "Used Good Trade Patterns: A Cross-Country Comparison of Electronic Secondary Markets," Working Papers 05-19, NET Institute, revised Oct 2005.
    2. Thomas W. Gilligan, 2004. "Lemons and Leases in the Used Business Aircraft Market," Journal of Political Economy, University of Chicago Press, vol. 112(5), pages 1157-1186, October.

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    More about this item

    Keywords

    E-Commerce; market substitution; adverse selection; efficient search and learning;
    All these keywords.

    JEL classification:

    • M21 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Business Economics - - - Business Economics
    • L1 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness

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