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Adverse Selection and Market Substitution by Electronic Trade

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  • Oliver Fabel
  • Erik Lehmann

Abstract

Adverse selection induces economic limits to market substitution. If quality uncertainty persists in both Internet and traditional marketplaces, a second-best equilibrium with parallel market segments may arise. The information cost advantage of one marketplace is exactly offset by a more severe adverse selection problem associated with non-observable quality variables. The electronic marketplace providing dominant search means contains all segments, while the traditional market may lack some segments. These missing segments are characterized by low quality expectations given the set of advertised quality signals. The analytic results are confirmed by an empirical investigation of used-car trade. Thus the study also provides an estimate of the price differential between the electronic and the traditional marketplace.

Suggested Citation

  • Oliver Fabel & Erik Lehmann, 2002. "Adverse Selection and Market Substitution by Electronic Trade," International Journal of the Economics of Business, Taylor & Francis Journals, vol. 9(2), pages 175-193.
    • Handle: RePEc:taf:ijecbs:v:9:y:2002:i:2:p:175-193
    DOI: 10.1080/13571510210134646
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    References listed on IDEAS

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    1. Bond, Eric W, 1982. "A Direct Test of the "Lemons" Model: The Market for Used Pickup Trucks," American Economic Review, American Economic Association, vol. 72(4), pages 836-840, September.
    2. George A. Akerlof, 1970. "The Market for "Lemons": Quality Uncertainty and the Market Mechanism," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 84(3), pages 488-500.
    3. R. G. Lipsey & Kelvin Lancaster, 1956. "The General Theory of Second Best," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 24(1), pages 11-32.
    4. Kirby, Alison J., 1993. "Optimal information exchange," Information Economics and Policy, Elsevier, vol. 5(1), pages 5-29, January.
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    Cited by:

    1. Miguel Angel Ropero García, 2013. "Effects of Competition and Quality on Hotel Pricing Policies in an Online Travel Agency," Tourism Economics, , vol. 19(1), pages 63-76, February.
    2. Fabel, Oliver, 2001. "The emergence of a new economy: An O-Ring approach," Discussion Papers, Series I 314, University of Konstanz, Department of Economics.
    3. Erik Lehmann, 2003. "Pricing Behavior on the WEB: Evidence from Online Travel Agencies," Empirica, Springer;Austrian Institute for Economic Research;Austrian Economic Association, vol. 30(4), pages 379-396, December.
    4. Winifred Huang & Michele Meoli & Silvio Vismara, 2020. "The geography of initial coin offerings," Small Business Economics, Springer, vol. 55(1), pages 77-102, June.
    5. Rach, Sabine & Tschöpel, Michael, 2011. "Handelsplattformen im Internet: Eine Literaturstudie zur empirischen Evidenz," Arbeitspapiere 112, University of Münster, Institute for Cooperatives.

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