Why Peaches Must Circulate Longer than Lemons

Abstract

This paper considers a competitive search market where sellers have private information about a good's quality. It is shown that separation of types may arise naturally if high-quality sellers derive a greater utility from search than low-quality sellers. For instance, sellers of high-quality goods may have to invest less time and money on repairs or spare parts than low-quality sellers or simply face a lower probability that the good breaks down before it is sold. In equilibrium, high-quality goods sell at a higher price, but also circulate longer than low-quality goods to ensure that low-quality sellers do not enter the market for high-quality goods. This holds even if an explicit sorting variable (e.g. warranties, advertising) does not exist. Moreover, all members of the short side of the market engage in trade, which is in contrast to the standard analysis where part of the short side of the market may not be served despite the presence of gains from trade