Abstract
This article studies the impact of competition on the degree of inefficiency in lemons markets. More precisely, we characterise the second‐best mechanism (i.e. the optimal mechanism with private information) in a stylised lemons market with finite numbers of buyers and sellers. We then study the relationship between the degree of efficiency of the second‐best mechanism and market competitiveness. A general message of our results is that increasing competition may not help lemons markets in some circumstances. Moreover, increasing competition beyond a certain degree increases the distance between the first‐best and second‐best levels of efficiency.
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