Information and the Organization of Markets: Theory and Experiments

This paper studies the link between market structure and the informativeness of publicly and privately observed market signals in an environment where sellers are het-erogeneous in production costs and prone to moral hazard. Sellers in the market have the option to credibly certify their goods at a cost, giving rise to both a pooling mar-ket equilibrium where no sellers use certification and a separating market equilibrium where some sellers certify their goods. The separating equilibrium eliminates important information regarding the underlying distribution of seller types and makes evaluating counterfactual market structures difficult. In a dynamic experimental setting, we study whether the information externality in the separating equilibrium can limit adaptation to the more efficient pooling equilibrium when market conditions improve. Consistent with theory, we find inefficient persistence when the separating equilibrium has ini-tially formed, but efficient adaptation in other situations. These results suggest that information externalities inherent in markets themselves can have a profound impact on their adaptability and long-run efficiency