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Negative Externalities and Equilibrium Existence in Competitive Markets with Adverse Selection

Author

Listed:
  • von Siemens, Ferdinand

    () (University of Amsterdam)

  • Kosfeld, Michael

    () (Goethe University Frankfurt)

Abstract

Rothschild and Stiglitz (1976) show that there need not exist a competitive equilibrium in markets with adverse selection. Building on their framework we demonstrate that externalities between agents ? an agent's utility upon accepting a contract depends on the average type attracted by the respective principal ? can solve the equilibrium existence problem, even when the size of the externalities is arbitrarily small. Our result highlights the degree of control a principal has over the attractiveness of his contracts as an important feature for equilibrium existence, thereby offering a new perspective on existing theories of competition in markets with adverse selection.

Suggested Citation

  • von Siemens, Ferdinand & Kosfeld, Michael, 2009. "Negative Externalities and Equilibrium Existence in Competitive Markets with Adverse Selection," IZA Discussion Papers 4125, Institute for the Study of Labor (IZA).
  • Handle: RePEc:iza:izadps:dp4125
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    References listed on IDEAS

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    1. Douglas Gale, 1992. "A Walrasian Theory of Markets with Adverse Selection," Review of Economic Studies, Oxford University Press, vol. 59(2), pages 229-255.
    2. Riley, John G, 1979. "Informational Equilibrium," Econometrica, Econometric Society, vol. 47(2), pages 331-359, March.
    3. Hellwig, Martin, 1987. "Some recent developments in the theory of competition in markets with adverse selection ," European Economic Review, Elsevier, vol. 31(1-2), pages 319-325.
    4. Bester, Helmut, 1985. "Screening vs. Rationing in Credit Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 75(4), pages 850-855, September.
    5. In-Koo Cho & David M. Kreps, 1987. "Signaling Games and Stable Equilibria," The Quarterly Journal of Economics, Oxford University Press, vol. 102(2), pages 179-221.
    6. Pradeep Dubey & John Geanakoplos, 2002. "Competitive Pooling: Rothschild-Stiglitz Reconsidered," The Quarterly Journal of Economics, Oxford University Press, vol. 117(4), pages 1529-1570.
    7. Dalmazzo, Alberto, 2002. " Technological Complexity, Wage Differentials and Unemployment," Scandinavian Journal of Economics, Wiley Blackwell, vol. 104(4), pages 515-530, December.
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    Cited by:

    1. Theodoros M. Diasakos & Kostas Koufopoulos, 2011. "Efficient Nash Equilibrium under Adverse Selection," Carlo Alberto Notebooks 215, Collegio Carlo Alberto.

    More about this item

    Keywords

    asymmetric information; competition; adverse selection; externality;

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law

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