The Market for “Lemons”:The Market for “Lemons”:Quality Uncertainty and the Market Quality Uncertainty and the Market MechanismMechanismGeorge A. George A. AkerlofAkerlofNiels Hoven9/30/2003IntroductionIntroductionQuality vs. uncertaintyQuality vs. uncertaintyEconomic costs of dishonestyEconomic costs of dishonestyCounteracting institutionsCounteracting institutionsAssumptionsAssumptionsGoodsGoodsVarying qualityVarying qualityBuyersBuyersJudge goods by market statisticJudge goods by market statisticSellersSellersKnow quality of own goodsKnow quality of own goodsAutomobile MarketAutomobile MarketLeaving the showroomLeaving the showroomAsymmetry in available informationAsymmetry in available informationOwners locked inOwners locked inGresham’s lawGresham’s lawAsymmetrical InformationAsymmetrical Informationp = pricep = priceµ = average quality of traded carsµ = average quality of traded carsD = demandD = demandS = supplyS = supplyµ = µ(p)µ = µ(p)D = D = D(pD(p, µ) = , µ) = D(pD(p, µ(p)), µ(p))S = S = S(pS(p))D(pD(p, µ(p)) = , µ(p)) = S(pS(p))AssumptionsAssumptionsUU11= M + = M + ΣΣxxiiUU22= M + = M + ΣΣ(3/2)x(3/2)xiiYY11, Y, Y22= income= incomeAssumptionsAssumptionsLinear utilityLinear utilitykk--ththcar adds same utility as 1car adds same utility as 1ststAll traders wish to maximize utilityAll traders wish to maximize utilityGroup 1 has N carsGroup 1 has N carsQuality = x ~ unif(0,2)Quality = x ~ unif(0,2)DemandDemandDD11= Y= Y11/ p/ pp < µp < µDD11= 0= 0p > µp > µDD22= Y= Y22/ p/ pp < 3µ / 2p < 3µ / 2DD22= 0= 0p > 3µ / 2p > 3µ / 2Problem:Problem:Price = pPrice = pµ = p/2µ = p/2Symmetric InformationSymmetric InformationS(pS(p) = N) = Np > 1p > 1S(pS(p) = 0) = 0p < 1p < 1D(pD(p) = (Y) = (Y22+ Y+ Y11)/ p)/ pp < 1p < 1D(pD(p) = Y) = Y2 2 / p/ p1 < p < 3/21 < p < 3/2D(pD(p) = 0) = 03/2 < p3/2 < pEquilibriumEquilibriumSymmetric caseSymmetric casep = 3/2p = 3/2if N < Yif N < Y2 2 / (3/2)/ (3/2)p = Yp = Y2 2 / N / N if Yif Y22/ (3/2) < N < Y/ (3/2) < N < Y22p = 1p = 1if Yif Y2 2 < N< NGain in utilityGain in utilityN / 2 N / 2 if N < Yif N < Y22YY22/2/2if Yif Y22< N< NInsuranceInsurancePeople over 65People over 65Difficult to buy insuranceDifficult to buy insuranceWhy doesn’t price rise to match the risk?Why doesn’t price rise to match the risk?Average medical condition vs. priceAverage medical condition vs. priceToo many lemons!Too many lemons!MedicareMedicareMoneylendersMoneylendersLeading factor in landlessnessLeading factor in landlessnessLarge banksLarge banks6, 8, or 10% interest6, 8, or 10% interestcan enforce contractcan enforce contractLocal moneylendersLocal moneylenders15, 25, 50% interest15, 25, 50% interestknows borrower’s characterknows borrower’s characterMinority EmploymentMinority EmploymentRace may serve as statisticRace may serve as statisticSocial backgroundSocial backgroundQuality of schoolingQuality of schoolingGeneral job capabilitiesGeneral job capabilitiesSlum schoolsSlum schoolsGrades unreliableGrades unreliableRewards for work accrue to groupRewards for work accrue to groupCostCost--benefit analysis problematicbenefit analysis problematicCosts of DishonestyCosts of DishonestyPurchasers cheatedPurchasers cheatedHonest dealings driven out of marketHonest dealings driven out of market½ unit of utility / automobile½ unit of utility / automobileUnderdeveloped countriesUnderdeveloped countriesQuality variation greaterQuality variation greaterVariation impedes developmentVariation impedes developmentMerchant tradersMerchant tradersEntrepreneurshipEntrepreneurshipCounteracting institutionsCounteracting institutionsGuaranteesGuaranteesBrandBrand--name goodname goodChainsChainsLicensing practicesLicensing practicesIndian industrial sceneIndian industrial sceneManaging agenciesManaging agenciesReputation for “honest dealing”Reputation for “honest dealing”Communal groupsCommunal groupsConclusionConclusion“Informal unwritten guarantees are preconditions “Informal unwritten guarantees are preconditions for trade and production. Where these for trade and production. Where these guarantees are indefinite, business will suffer.”guarantees are indefinite, business will
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