Abstract
This paper explores how the structure of asymmetric information impacts on economic outcomes in Akerlof’s (Q J Econ 84(3):488–500, 1970) Lemons model applied to the labour market and extended to admit a matching component between worker and firm. We characterize the nature of equilibrium and define measures of adverse selection and efficiency. We then characterize the joint distribution of outcomes—adverse selection, probability of trade, efficiency, profits, and wage—for the class of Gaussian basic games and information, and perform comparative statics with respect to a parsimonious parameterization of the information structure. We use this framework to revisit the classic issue, first addressed by Roy (Oxford Econ Pap 3(2):135-146, 1951), of selection into different sectors. We identify conditions under which an effect reversal—adverse selection at any realisation of public information but, overall, positive selection into the outside sector—can and cannot arise, and note the implications for empirical work. We also explore the divisions of expected total surplus between worker and firm that can be achieved as information varies. We show that, if the distribution of worker types is non-singular, any point in the set of possible surplus divisions can be achieved as a limit of a PBE for some information structure with asymmetric information. Finally, re-interpreting the model in an insurance context, where the matching component becomes consumer risk aversion, we use our framework to highlight sources of advantageous selection.
Highlights
We aim to characterize how the structure of asymmetric information impacts economic outcomes in a natural generalization of Akerlof’s (1970) Lemons model.We couch our discussion in terms of an employer learning model of the labour market, giving a brief discussion of insurance
Only one point on the efficiency frontier can be reached, any point in the interior of the feasible set can be achieved as a unique Perfect Bayesian Equilibrium (PBE) payoff pair in a game with asymmetric information, if there is a non-singular distribution of types
Under which information structures is the average general productivity of released workers higher than the average general productivity of retained workers? In particular, can there be an effect reversal (Yule 1903; Simpson 1951)—that is, adverse selection at any T but, on average, positive selection of general productivity into the outside market? Second, under which information structures is the average wage of released workers higher than the average wage of retained workers? In particular, can released workers earn a premium over retained workers even in the presence of adverse selection?
Summary
We aim to characterize how the structure of asymmetric information impacts economic outcomes in a natural generalization of Akerlof’s (1970) Lemons model. To aid interpretation of these characterization results, we discuss a special case of our model where the worker’s outside productivity is linearly related to her inside productivity In this scalar types case, there are just two free parameters, corresponding to: (a) the quality of public information; and (b) the information gap (Levin 2001), i.e. how much extra information the inside firm has over and above public information. 4 apply and have an immediate corollary: advantageous selection occurs if and only if the risky loss and coefficient of risk aversion are sufficiently negatively correlated compared to the amount of asymmetric information It follows from this condition that scaling up the risk, holding everything else in the model constant, could replace a situation of adverse selection with one of advantageous selection. We conclude by comparing this result to those in Fang and Wu (2018)
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