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The Nature of Equilibrium in Markets with Adverse Selection

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  • Charles Wilson

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.

Suggested Citation

  • Charles Wilson, 1980. "The Nature of Equilibrium in Markets with Adverse Selection," Bell Journal of Economics, The RAND Corporation, vol. 11(1), pages 108-130, Spring.
  • Handle: RePEc:rje:bellje:v:11:y:1980:i:spring:p:108-130
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