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Adverse Selection in Durable Goods Markets

  • Igal Hendel
  • Alessandro Lizzeri

An undesirable feature of Akerlof style models of adverse selection is that ownership of" used cars is independent of preferences and is therefore ad hoc. We present a dynamic model" that incorporates the market for new goods. Consumers self-select into buying new or used" goods making ownership of used goods endogenous. We show that, in contrast with Akerlof and" in agreement with reality, the used market never shuts down and that the volume of trade can be" quite substantial even in cases with severe informational asymmetries. By incorporating the" market for new goods, the model lends itself to a study of the effects of adverse selection on" manufacturers' incentives. We find that manufacturers may gain from adverse selection. We" also give an example in which the market allocation under adverse selection is socially optimal. " An extension of the model to a world with many brands that differ in reliability leads to testable" predictions of the effects of adverse selection. We show that unreliable car brands have steeper" price declines and lower volumes of trade.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 6194.

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Date of creation: Sep 1997
Date of revision:
Publication status: published as American Economic Review, Vol. 89, no. 5 (December 1999): 1097-1115.
Handle: RePEc:nbr:nberwo:6194
Note: IO
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  1. ANDERSON, Simon P. & GINSBURGH, Victor A., . "Price discrimination via second-hand markets," CORE Discussion Papers RP -1078, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  2. Bond, Eric W, 1982. "A Direct Test of the "Lemons" Model: The Market for Used Pickup Trucks," American Economic Review, American Economic Association, vol. 72(4), pages 836-40, September.
  3. Grossman, Sanford J, 1981. "The Informational Role of Warranties and Private Disclosure about Product Quality," Journal of Law and Economics, University of Chicago Press, vol. 24(3), pages 461-83, December.
  4. Genesove, David, 1993. "Adverse Selection in the Wholesale Used Car Market," Journal of Political Economy, University of Chicago Press, vol. 101(4), pages 644-65, August.
  5. Igal Hendel & Alessandro Lizzeri, 1997. "Adverse Selection in Durable Goods Markets," NBER Working Papers 6194, National Bureau of Economic Research, Inc.
  6. Bigelow, John P., 1990. "Efficiency and adverse selection," Journal of Economic Theory, Elsevier, vol. 52(2), pages 380-405, December.
  7. Akerlof, George A, 1970. "The Market for 'Lemons': Quality Uncertainty and the Market Mechanism," The Quarterly Journal of Economics, MIT Press, vol. 84(3), pages 488-500, August.
  8. Kim, Jae-Cheol, 1985. "The Market for "Lemons" Reconsidered: A Model of the Used Car Market with Asymmetric Information," American Economic Review, American Economic Association, vol. 75(4), pages 836-43, September.
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