Price Discrimination in Markets for Lemons

Abstract

Should insurance prices vary with age? I consider competitive markets for lemons where a signal (eg, age) partitions consumers (eg, young and old). I study the continuum of policies from zero price-discrimination (zero-PD, equal prices) and full-PD (no restrictions). Restricting PD increases welfare if high-cost markets exhibit greater adverse selection. I characterize optimal PD, and show how it is affected by changes in cost. Full-PD is preferable if one market unravels. In a calibration, optimal PD increases welfare by about $30/person-year. I extend the model to arbitrary signal structures, behavioral consumers, a monopolized industry, and multi-product firms.

Keywords: Adverse Selection, Price Discrimination

JEL Classification: D82, L52,D41