Efficient Price Competition in Markets with Adverse Selection

Abstract

This paper studies general markets with adverse selection in which symmetric firms supply (potentially multiple) products to privately-informed consumers and compete with price schedules. I show that a basic price cap regulation, in which the price caps are endogenously determined by firms, alongside the possibility of firms to react to price cuts a la Wilson (1977), discourages risk selection over efficient allocations, and therefore, equilibrium exists in every market. Moreover, I demonstrate that in the markets that are considerably more general than the stylised Rothschild and Stiglitz (1976) insurance market, firms earn zero profits in equilibrium, and every equilibrium allocation is efficient.