Imperfect Competition in Markets with Selection

Abstract

This paper proposes a spatial model of imperfect competition in markets with selection to investigate whether imperfect competition exacerbates or offsets inefficiencies caused by selection. We find that no degree of imperfect competition achieves the first-best efficient allocation. This holds in markets with adverse selection and even in markets with advantageous selection, where perfect competition results in inefficient overprovision. Overprovision induced by advantageous selection and underprovision caused by market power do not cancel out perfectly. Instead, they co-exist for different consumers. The exact allocation depends on whether firms use uniform prices or price discriminate. However, we show that the efficient allocation can be reached through a combination of a corrective tax and tough competition policy. Overall, our results caution against viewing imperfect competition as a solution to the inefficiencies introduced by selection.