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Pre-trade private investments

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  • Dilmé, Francesc

Abstract

This paper investigates the welfare effects of private investments prior to trade. A seller of a durable good can privately invest on changing its quality. After the investment, she receives a take-it-or-leave-it offer from a buyer. Both the seller and the buyer value more goods of higher quality. We obtain that, in equilibrium, the seller mixes the investment choice, adding adverse selection to the exchange. The non-observability of the investment diminishes the buyer's payoff without giving the seller additional rents. Notably, adding buyer competition exacerbates the adverse selection and completely eliminates the trade surplus. Partial observability increases the equilibrium investment, makes the seller better off, and reduces the payoff of the buyer.

Suggested Citation

  • Dilmé, Francesc, 2019. "Pre-trade private investments," Games and Economic Behavior, Elsevier, vol. 117(C), pages 98-119.
    • Handle: RePEc:eee:gamebe:v:117:y:2019:i:c:p:98-119
    DOI: 10.1016/j.geb.2019.05.008
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    References listed on IDEAS

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    Cited by:

    1. Daniel Krähmer, 2024. "The Hold-Up Problem with Flexible Unobservable Investments," ECONtribute Discussion Papers Series 278, University of Bonn and University of Cologne, Germany.
    2. Peter Wagner, 2023. "Seller experimentation and trade," Review of Economic Design, Springer;Society for Economic Design, vol. 27(2), pages 337-357, June.

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    More about this item

    Keywords

    Private investment; Hold up problem; Price dispersion;
    All these keywords.

    JEL classification:

    • 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
    • D42 - Microeconomics - - Market Structure, Pricing, and Design - - - Monopoly
    • L15 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Information and Product Quality

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