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  5. Optimal Trade Mechanisms with Adverse Selection and Inferential Naivety

òòò½Íø Journal:
Microeconomics

ISSN 1945-7669 (Print) | ISSN 1945-7685 (Online)

Optimal Trade Mechanisms with Adverse Selection and Inferential Naivety

  • Takeshi Murooka
  • Takuro Yamashita
òòò½Íø Journal: Microeconomics (Forthcoming)

Abstract

We study an adverse selection environment in which a buyer’s inferential ability is heterogeneous: A rational type correctly infers the value of the good from a seller’s offer, whereas a naive type is inattentive to the correlation between the seller’s private information and the offer. We characterize the optimal menu mechanism that maximizes the seller’s profits or trade surplus. Notably, no matter how severe the adverse selection is, all types of buyers trade. We then provide conditions under which the menu mechanism is optimal among all general mechanisms. A consumer-protection policy that limits the naive buyer’s loss is also investigated.

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