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Article - akerlof (market for lemon)

8 important questions on Article - akerlof (market for lemon)

How is there assymetry in the automobile market?

asymmetry in available information: seller has more knowledge about the car than the buyer.

Why do good and bad cars have to be selled at the same price?

But good and bad cars must sell at same price, since it’s impossible for buyer to tell the difference between a good or bad car

Gresham’s law:

most cars traded will be lemons and good cars may not be traded at all. The bad cars drive out the good, because they sell at the same price. In the extreme case no good cars are sold in the market anymore because the sellers of good cars are not willing to sell their car for the lower price.

Demand for used automobiles depends on two variables: the price of the automobile and the average quality of used cars traded. Conclusion:

average quality of used cars fell with a corresponding fall in price

As price level rises, the people who insure themselves will be those who are increasingly certain that they need insurance. Average medical condition of insurance applicants deteriorates as the price level rises →

adverse selection. Healthy insurance policy holders may terminate their coverage when they become older and premiums rise.

What is the solution to adverse selection

Solution: group insurance (group of employees for example) → picks out the healthy, since health is a precondition for employment. This means medical insurance is least available to those who need it most, since insurance companies do their own “adverse selection”.

Descibe the cost of dishonesty

Cost of dishonesty: amount by which purchaser is cheated + loss incurred from legitimate businesses going out of business. Dishonesty in business is a serious problem in underdeveloped countries because it is more difficult to assess quality.

Numerous institution arise to counteract the effects of quality uncertainty, such as guarantees/warranty. Most consumer durables carry guarantees to ensure the buyer of some normal expected quality. Risk is borne by seller instead of the buyer. Another institution to assess quality: brand-name good. Brand names indicate the quality and gives consumer the means of retaliation if the quality doesn’t meet expectations.

Numerous institution arise to counteract the effects of quality uncertainty, such as guarantees/warranty. Most consumer durables carry guarantees to ensure the buyer of some normal expected quality. Risk is borne by seller instead of the buyer. Another institution to assess quality: brand-name good. Brand names indicate the quality and gives consumer the means of retaliation if the quality doesn’t meet expectations.