Journal of Mathematical Economics 48 (2012) 187–195 Contents lists available at SciVerse ScienceDirect Journal of Mathematical Economics journal homepage: www.elsevier.com/locate/jmateco General equilibrium in markets for lemons ✩ João Correia-da-Silva ∗ Universidade do Porto, CEF.UP and Faculdade de Economia, Rua Dr. Roberto Frias, 4200-464 Porto, Portugal article info Article history: Received 13 June 2010 Received in revised form 10 October 2011 Accepted 13 April 2012 Available online 25 April 2012 Keywords: General equilibrium Asymmetric information Adverse selection Uncertain delivery Delivery rates abstract This paper studies exchange economies in which agents have differential information about the goods that the other agents bring to the market. To study such a setting, it is useful to distinguish goods not only by their physical characteristics, but also by the agent that brings them to the market. Equilibrium is shown to exist, with agents receiving the cheapest bundle among those that they cannot distinguish from the truthful delivery. An example is presented as an illustration. © 2012 Elsevier B.V. All rights reserved. 1. Introduction Economic agents usually trade goods without having perfect knowledge of their characteristics. This applies to firms hiring workers with unknown productivity, to consumers buying used cars with unknown quality and to financial institutions buying assets with unknown return. Each trader enters the market with specific prior knowledge and observation abilities concerning the characteristics of the goods being traded. This is a particular kind of asymmetric information (adverse selection), famous since the seminal contribution of Akerlof (1970). General equilibrium models with adverse selection have been developed by Prescott and Townsend (1984a,b), Gale (1992, 1996), Bisin and Gottardi (1999, 2006) and Rustichini and Siconolfi (2008), among others. In these models, agents enter the market having private information about their endowments and preferences in each of the possible states of nature. Here, an alternative formulation is considered. Each agent’s private information is described by a partition of the set of commodities, such that ✩ I am grateful to Andrés Carvajal, Carlos Hervés Beloso, Herakles Polemarchakis, an anonymous referee and an Associate Editor for useful comments and suggestions that allowed me to improve the paper, and to Joana Pinho for assisting me with the computations. I also wish to thank the participants in seminars at the Paris School of Economics, U. Vienna, U. Warwick, U. Reading, U. Exeter and U. Porto, in the 2009 European GE Workshop in honor of Andreu Mas-Colell, in the 2009 SAET Conference and in the 2009 UECE Game Theory Meeting in Lisbon. Financial support from CEF.UP, Fundação para a Ciência e Tecnologia and FEDER (research grant PTDC/EGE-ECO/111811/2009) is acknowledged. ∗ Tel.: +351 225571100; fax: +351 225505050. E-mail address: joao@fep.up.pt. the agent can only distinguish goods that belong to different sets of the partition. This formulation, in the spirit of Akerlof (1970), was proposed by Minelli and Polemarchakis (2000) and Meier et al. (2011). The distinctive feature of the work of Meier et al. (2011) is the consideration of what they designate as two-sided private infor- mation: agents are allowed to have differential information about the goods that the other agents bring to the market (instead of being equally uninformed). 1 This contrasts with what is assumed in all the previous literature. For example, in the model of Dubey et al. (2005), in which sellers of an asset may or may not default on their promises of future payments, all the buyers receive the same payoff (because deliveries are pooled). If one recognizes that some buyers have superior abilities to identify the sellers who are more likely to default, then it becomes essential to study how and to what extent they are able to exploit their informational advantage. The model of Meier et al. (2011) is intended for the pursuit of such an investigation. A drawback of their formulation is that it only allows for the opening of markets for classes of goods that everyone can distinguish. For example, if there is an agent in the economy that does not distinguish red cherries from green cherries, then the other agents cannot trade red and green cherries at different prices. The existence of a single uninformed buyer 1 Agents are assumed to have perfect information about their endowments, and only have differential information about the characteristics of the goods that are brought to the market by the other agents. This is a natural assumption, based on the observation that the owner of a good typically has superior information about its characteristics. 0304-4068/$ – see front matter © 2012 Elsevier B.V. All rights reserved. doi:10.1016/j.jmateco.2012.04.002