On the Existence of Positive Equilibrium Profits in Competitive Screening Markets

Abstract

We assume a fixed number of symmetric firms, competition in prices, constant returns to scale and frictionless consumer choices. Consumers differ in their preferences and profitability (e.g., due to heterogeneous risk aversion and loss probabilities), which creates adverse selection. Firms can offer multiple contracts to screen individuals, in equilibrium and in any deviation. We show that equilibrium profits vanish if each consumer has a unique optimising bundle at equilibrium prices or, more generally, if there exists a linear ordering over of contracts that dictates the preferences of firms whenever consumers are indifferent between multiple optimal contracts. For instance, equilibrium profits vanish if the marginal rate of substitution of quality for price is sharper for profit than for utility. In particular, profit also vanishes if utility equals the sum of (negative) profit, and a surplus (eg, due to risk aversion). We pro- vide examples of economies where there exists an equilibrium with strictly positive profit and show that these examples are robust (hold for an open set of economies).

Keywords: Perfect Competition, Equilibrium, Screening

JEL Classification: D41, C62, D82, G22