Adverse Selection and Endogeous Information

This paper studies adverse selection markets in which consumers can choose to learn how much they value a product. Information is acquired after observing prices, so it is endogenous. This presents a trade-off: information increases the quality of consumers’ choices but worsens selection. We characterize how this trade-off translates into distortions of consumers’ demand and producers’ cost. We show that information decisions produce a negative externality, may decrease welfare, and may lead to new forms of market breakdown. Moreover, efficiency is typically non-monotone in information costs. Two implications are that (1) standard measures underestimate the welfare costs of adverse selection; and (2) information policies can help correct its inefficiencies. Finally, we construct an empirical test to detect endogenous information in the data, and develop a framework for counterfactual policy analysis.