638 QUARTERLY JOURNAL OF ECONOMICS
I. 7 Welfare Economics of Equilibrium
One of the interesting properties of the equilibrium is that the presence of the high-risk individuals exerts a negative externality on the low-risk individuals. The externality is completely dissipative; there are losses to the low-risk individuals, but the high-risk indi- viduals are no better off than they would be in isolation. If only the high-risk individuals would admit to their having high accident probabilities, all individuals would be made better off without anyone being worse off. The separating equilibrium we have described may not be Pareto optimal even relative to the information that is available. As we show in subsection 11.3 below, there may exist a pair of policies that break even together and that make both groups better off.