Honesty in markets with asymmetric information

We consider a game-theoretic version of Akerlof's market for lemons where the seller makes a take-it-or-leave-it price offer and a statement to the buyer about the quality of the car. We derive the set of equilibria when there is some probability that the seller is honest in the sense that he incurs a deception cost when he lies. We then find the socially optimal level for the deception cost and the proportion of honest sellers in the population. In equilibrium, the seller's message never conveys any information not already contained in the price, so the role of honesty in our model is not to ensure informative communication but rather to deter mimicry. We also show that the relationship between honesty and efficiency isnon-monotonic in the sense that an increase in honesty can reduce efficiency. The main result of the paper is that the social optimum can be characterized by an arbitrarily small proportion of honest sellers and yet still achieve efficiency