Trade under Asymmetric Information

Abstract This chapter examines trade and policy formulation when there is asymmetric information about firm costs and the level of demand. Asymmetric information raises the issue of how to convey or extract unobserved information. For instance, which mechanisms induce type revelation by a firm holding private information about whether it is a low- or a high-cost type? Types can be revealed by screening and signaling. In a screening game, the government designs a mechanism inducing firms to reveal their type. In signaling games, firms take the initiative and make a costly choice, such as increasing research spending or incurring the costs of developing an infra- structure for exporting (Shy, 2000), to signal their type to the government, rival firms or consumers.