Endogenous market segmentation for lemons


  • This article is based on a chapter of my doctoral dissertation at the University of Pennsylvania. I am deeply indebted to my advisors, George Mailath and Andrew Postlewaite, for their generous guidance and support. I am very grateful to Philipp Kircher, Benjamin Hermalin, and two anonymous referees for many insightful discussions. I also thank Yeon-Koo Che, David Dillenberger, Jan Eeckhout, Navin Kartik, Ayca Kaya, Soojin Kim, Timothy Van Zandt, Randall Wright, and seminar participants at various places for helpful comments.


Information asymmetry between sellers and buyers often prevents socially desirable trade. This article presents a new mechanism that mitigates the inefficiencies caused by information asymmetry. I consider decentralized markets under adverse selection and show that such markets can be endogenously segmented in a way that 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 nonbinding list prices.