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this seems to us a reasonable equilibrium concept for the models of educational signaling on which Spence focused, it is less compelling when applied to insurance or credit markets (see Jaffee and Russell's contribution to this symposium). A local equilibrium is a set of contracts such that there do not exist any contracts in the vicinity of the equilibrium contracts that will be chosen and make a positive profit. If we rule out the subsidies of the last subsection, then the set of separating contracts, which maximizes the welfare of low-risk individuals, is a local equilibri- um.