The New Debate
Edited by Tyler Cowen and Eric Crampton
Chapter 4: The market for 'lemons': quality uncertainty and the market mechanism
4. The market for ÔlemonsÕ: quality uncertainty and the market mechanism George A. Akerlof1 I. INTRODUCTION This chapter relates quality and uncertainty. The existence of goods of many grades poses interesting and important problems for the theory of markets. On the one hand, the interaction of quality differences and uncertainty may explain important institutions of the labor market. On the other hand, this chapter presents a struggling attempt to give structure to the statement: ÔBusiness in underdeveloped countries is difficultÕ; in particular, a structure is given for determining the economic costs of dishonesty. Additional applications of the theory include comments on the structure of money markets, on the notion of Ôinsurability,Õ on the liquidity of durables, and on brand-name goods. There are many markets in which buyers use some market statistic to judge the quality of prospective purchases. In this case there is incentive for sellers to market poor-quality merchandise, since the returns for good quality accrue mainly to the entire group whose statistic is affected rather than to the individual seller. As a result there tends to be a reduction in the average quality of goods and also in the size of the market. It should also be perceived that in these markets social and private returns differ, and therefore, in some cases, governmental intervention may increase the welfare of all parties. Or private institutions may arise to take advantage of the potential increases in welfare which can accrue to all parties. By nature, however, these institutions are nonatomistic,...
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