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Welfare effects of certification under latent adverse selection

Author

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  • Creane, Anthony
  • Jeitschko, Thomas D.
  • Sim, Kyoungbo

Abstract

Asymmetric information is a classic example of market failure that undermines the efficiency associated with perfectly competitive market outcomes: the "lemons" market. Credible certification, that substantiates unobservable characteristics of products that consumers value, is often considered a potential solution to such market failure. This paper examines welfare effects of certification in markets in which there is asymmetric information, but without an adverse selection problem. We analyze the market equilibrium when the certification technology becomes available and contrast this with the equilibrium without certification. We find that despite an improvement in allocative efficiency, overall welfare may decrease due to the possibility of certification when such certification is either costly or inaccurate. In fact, most of these results are not derived from the direct welfare cost of certification, but rather from certification's effect on the market(s).

Suggested Citation

  • Creane, Anthony & Jeitschko, Thomas D. & Sim, Kyoungbo, 2019. "Welfare effects of certification under latent adverse selection," DICE Discussion Papers 312, University of Düsseldorf, Düsseldorf Institute for Competition Economics (DICE).
  • Handle: RePEc:zbw:dicedp:312
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    References listed on IDEAS

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    More about this item

    Keywords

    credible certification; welfare-reducing certification; asymmetric information; adverse selection;
    All these keywords.

    JEL classification:

    • D8 - Microeconomics - - Information, Knowledge, and Uncertainty
    • D4 - Microeconomics - - Market Structure, Pricing, and Design
    • L1 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance

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