Endogenous Market Segmentation for Lemons

Information asymmetry between sellers and buyers often impedes socially desirable trade. This paper presents a new mechanism that mitigates the inefficiencies caused by information asymmetry. It is shown that markets under severe adverse selection can be endogenously segmented and such segmentation improves social welfare. Endogenous segmentation is driven by low-quality sellers’ incentive to attract more buyers by separating from high-quality sellers. The mechanism helps us understand the roles of several real-world institutions, such as multiple marketplaces, costless advertisements, and non-binding list prices. JEL Classification Numbers: C72, D82, D83.