Does signalling solve the lemons problem?

Abstract

Maybe. Lemons and signalling models generally deal with different welfare problems, the former with withdrawal of high quality sellers, and the latter with socially wasteful signals. Absent signalling, with asymmetric information, high productivity workers may not be employed where they are valued the most. If one’s productivity is known in alternative employment, signalling that overcomes the lemons problem will only occur if it increases welfare.

Keywords:

• Lemons
• signalling
• sorting

JEL Classification:

• C70
• D80
• D82

Notes

¹ In an appendix, Spence (1974) considers a two-sector model in which there is a social return to signalling from correctly allocating individuals to jobs. However, most signalling models ignore sorting gains. Exceptions are Perri (2015) and the analysis herein.

² If both types have the same productivity in the secondary sector, S2, it can be shown that signalling always occurs and increases welfare.

³ See Spence (1974) and Perri (2015).