The Market for Lemons
The Market for LemonsI & II Introduction and Article Summary
The Market for “Lemons”: Quality Uncertainty and the Market Mechanism by George A. Akerlof was published by the Oxford University Press in The Quarterly Journal of Economics in 1970. It discusses information asymmetry, which occurs when the seller knows more about a product than the buyer. Akerlof explains the problem of quality uncertainty with an example of the market for used cars. A used car is a car that has had one or more registered owners and has inevitable wear and tear. There are good used cars and bad used cars (lemons). A lemon is an American term for a car that is found to be defective only after it is bought. Used cars that are defective are called lemons, and most defects are attributed to several non-traceable variables such as maintenance, accidents, and previous owner’s driving style. The consumer buying the used car cannot tell if the car is a good car or a lemon, because most of the mechanical parts are hidden from view and not easy to access for inspection, so they assume that they are getting a car of average quality.
If a consumer were to try and sell a well-maintained good used car, they would only be able to get the price for an average used car, which would not make selling the good used car worthwhile. Therefore, owners of good used cars won’t place their cars on the used car market, which will reduce the average quality of cars on the market. This will make the average price fall due to lower quality cars on the market, and the market will decline until there is no more trade; the bad will drive out the good.
III Response to Question 1
Information asymmetry is where one party has more or better information than the other. This creates an imbalance of power in transactions. In the used car example, the sellers knew what condition the used cars were in, so they knew more than the buyers. The buyers had no idea what condition the used car was in, so they assume the car will be “average”....