co-author: Oved Yosha, (Tel-Aviv University).

status: Working Paper.

Abstract: In markets suffering from adverse selection low valuation individuals purchase too little of the good in question. We study the effectiveness of a particular form of gov- ernment intervention in such markets, centered on making sure that a certain contract be available on the market. Once this contract is available, private sellers respond optimally by offering contracts of their own, and buyers are free to buy from whoever they w ish. The intervention scheme increases the quantity purchased by low valuation individuals, in the competitive and the monopolistic cases. In both cases the interven- tion scheme generates a Hicks-Kaldor welfare improvement. The central feature of the post-intervention equilibrium is that high valuation individuals purchase the contract introduced by the government, whereas low valuation individuals purchase contracts sold by private firms. By targeting the "lemons" with an appropriately designed con- tract, the government makes it worthwhile for private firms to increase the quantity sold to low valuation individuals.

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