Adverse Selection in Durable Goods Markets

35 Pages Posted: 10 Jul 2000

See all articles by Igal Hendel

Igal Hendel

Northwestern University - Department of Economics; National Bureau of Economic Research (NBER)

Alessandro Lizzeri

Princeton University - Department of Economics

Date Written: September 1997

Abstract

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.

Suggested Citation

Hendel, Igal E. and Lizzeri, Alessandro, Adverse Selection in Durable Goods Markets (September 1997). NBER Working Paper No. w6194, Available at SSRN: https://ssrn.com/abstract=225951

Igal E. Hendel (Contact Author)

Northwestern University - Department of Economics ( email )

2003 Sheridan Road
Evanston, IL 60208
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Alessandro Lizzeri

Princeton University - Department of Economics ( email )

Princeton, NJ 08544-1021
United States
08544 (Fax)

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