Endogenous Market Segmentation for Lemons: Theory and Applications

Abstract

This paper explores the possibility of endogenous segmentation in a market where information asymmetry about the quality of goods may result in only low-quality goods trading (lemons problem). I consider a model in which there are multiple ex ante identical submarkets, agents costlessly choose submarkets to join, and exchanges take place in each submarket. In a submarket, each buyer randomly selects a seller and makes a take-it-or-leave-it offer. I demonstrate that a market suffering from the lemons problem can be endogenously segmented and high-quality goods, that cannot trade without segmentation, do trade with segmentation. The results have implications for several applied problems, such as the arrangement of multiple marketplaces or platforms, the informativeness of costless advertisements for experience goods, and the role of non-binding list prices in decentralized markets.

Keywords: Lemons Problem, Market Segmentation

JEL Classification: C72, D82, D83