Middlemen and private information

In this paper, private information concerning the quality of consumption goods is introduced to motivate the role of intermediation. Agents endogenously choose whether to become middlemen by investing in a technology of verifying quality. It is shown that there exists an equilibrium where middlemen always trade high-quality goods when the private information problem is not severe and the investment cost of quality-testing technology is not too high. When the private information problem is relatively severe, middlemen sometimes trade for low-quality goods. The trade-off to having agents engage in intermediation as opposed to production is considered to determine middlemen's welfare-improving role. It is found that when exchange is significantly delayed in the sense that people do not execute trades because they cannot recognize the true quality of goods, expert middlemen can improve welfare. (C) 1998 Elsevier Science B.V. All rights reserved.