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This paper studies the impact of competition on the degree of inefficiency in lemons markets. More precisely, the authors characterize the second-best mechanism (i.e., the optimal mechanism with private information) in a stylized lemons market with finite numbers of buyers and sellers. They then study the relationship between the degree of efficiency of the second-best mechanism and market competitiveness. The relationship between the first-best and second-best mechanisms is also explored. It is conventional wisdom that competition is a good thing. The more the better. By fostering appropriate individual incentives, competition can help promote aggregate (or social) welfare.
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