
The Market for Lemons - Ibethewalrus
https://en.wikipedia.org/wiki/The_Market_for_Lemons
======
mindcrime
Interesting, but there seem to be a lot of assumptions baked into the default
"used car market" example, that don't necessarily hold up. For example, the
idea that the owner knows whether they hold a "peach" or a "lemon". Clearly
he/she has _some_ idea, but they definitely do not have perfect knowledge of
this. In fact, this very lack of knowledge ("how many more miles will I get
out of this car before the transmission falls out?") may be the reason the
owner has chosen to manage risk by buying a newer car. But the actual answer
to that question could be anywhere from "1 more mile" to "another 250,000+
miles".

Likewise, this statement:

 _Given the fixed price at which buyers will buy, sellers will sell only when
they hold "lemons" (since plemon < pavg) and they will leave the market when
they hold "peaches"_

is iffy. As the owner of a used car, I may choose to buy a newer car for any
number of reasons, including just wanting something to impress my peers, or
impress members of the opposite sex, whatever. Say I buy a nice, sexy, new
sports-car. I don't need my old car anymore, regardless of whether it is a
peach or a lemon. But my decision to sell it may not involve its status as
"peach" or "lemon". It may simply be that I don't want to pay property taxes
and registration fees on a car I'm not using. Maybe I just don't have anywhere
to park a second car. Or maybe I'm just feeling generous and want to help
somebody else out by selling them my no-longer-needed car.

All of that said, I'm sure the math is valid and this theory has uses... but
this used car thing feels a little dodgy.

~~~
zwaps
It's a model. A pretty good one, since the mechanism at play here can occur in
a very general sense. The car market is an example where this effect may
occur, as is insurance and finance. However, in reality, there are many more
things going on that this model abstracts from. Nevertheless, the basic issue
of asymmetric information shown in this model exists, to some degree, among
other effects. You should not understand this paper as a statement about the
used car market.

So for example: You say the owner does not know whether it is a lemon or
peach. Well, the model is about asymmetry. Everything goes through if the
owner (on average) knows MORE than the buyer. I think that's pretty fair, and
if it is not the case, we are not dealing with an information asymmetry and
the model is silent on the matter. Similarly, clearly cars are not just two
types, lemon and peach. But again, results will hold if you make introduce
more and more classes. It just makes the math less simple.

You also say that some people do not sell their car because it is a lemon.
True. But again, on average, the rate of lemons for a given price will be
higher than it would be if you could identify the quality of a car exactly -
because it is sufficient that some people sell their lemons as peaches. You
could introduce all this in the model, you just probably wouldn't learn
anything new.

It's a good model, because its simple and even if you throw more stuff at it,
the mechanism persists to a degree. Clearly, in reality, more things are going
on than just this. But reading the paper we learn about an issue that exists
within the complex system, and that is valuable.

~~~
mindcrime
_But reading the paper we learn about an issue that exists within the complex
system, and that is valuable._

Agreed, that why I said "All of that said, I'm sure the math is valid and this
theory has uses." My criticism (if you want to call it that) isn't of the
fundamental, underlying theory... it's more with the specific example chose to
illustrate it. I suspect that there is a better example model they could have
chosen.

------
b1daly
The model makes sense within the limited domain of its assumptions.

I find it weird though that it uses an example of autos, because of the
hypothetical presence of asymmetric information, which doesn’t seem to
describe the real world well at all.

The quality of cars has risen dramatically and steadily over the years. There
are multiple mechanisms which compensate for the difficulties a lay person has
valuing a complex product.

In addition to government regulations, brand reputation is hugely important in
motivating automakers to make reliable products.

The subject is of keen interest to buyers, who actively seek out information
about potential quality of a new car purchase. In the pre-internet area it was
harder, but sources of information like Consumer Reports were well used.

Since brand perception is expensive to build, and easy to lose, my anecdotal
perception is that automakers try really hard to make great products.
Especially because if the sell someone a lemon, the customer will be stuck
with it for some time, increasing the opportunity for various types of
reputation harming communication.

In the used car market the forces that drive quality are passed right through.
While there is perhaps a higher chance of being stuck with a lemon, there are
plenty of countervailing forces.

In anycase it struck me as odd that the example the paper used to show the
intuition behind it was one that my perspective is almost the opposite of.

I guess the general principle I’m alluding it is that in markets that have a
high potential for asymmetric information problems, the problems are obvious,
and potential buyers will actively use strategies to compensate.

~~~
argonaut
The paper was written in 1970. The car market today is drastically different
to the market then.

~~~
sonnyblarney
The point of the paper is not 'cars', it's 'information asymmetry'.

------
chiph
Hidden information? I made it crystal clear what the car was.

[https://imgur.com/a/NQuVomI](https://imgur.com/a/NQuVomI)

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throwaway13337
This explains the way consumer app markets go.

App stores cause downward pressure on average prices of apps. Free now being
most common.

This drives away high quality app developers where the consumer and the
business interests align.

Now there is only a market for user hostile, free consumer software due to
this feedback loop reaching its end.

~~~
randomsearch
So no one makes money from software nowadays?

~~~
TeMPOraL
Some do, if they can find a way to survive or avoid competitors with
cheaper/free offerings that are ad-supported or subsidized by VC money.

------
padobson
I wonder if there's a tipping point in information asymmetry where the theory
becomes irrelevant. Sellers will almost always have more information than
buyers about a specific instance of a product, but there comes a point in a
market where buyers have ENOUGH information to avoid buying a lemon, and so
can adjust their offer based on that information and disrupt the feedback loop
that drives peach owners out of the market.

As an example, you probably could have done very well for yourself in 2009
buying mortgage-backed securities that didn't include any subprime loans. The
securities may have had other problems, but at some point there was enough
information available to stop buying the lemon securities for subprime loans
and pay a bit more than p.avg for the security if it wasn't backed by subprime
loans. Information asymmetry still exists, but there's enough information
available to avoid making a catastrophic purchase.

So it's almost like the market for lemons is forced to self-correct, because
the quality of the product in the market will necessarily drop until it
becomes obvious to the buyers what attributes distinguish between a lemon and
a peach.

So maybe the chief lesson in The Market for Lemons is if it looks like a
market is all peaches, you shouldn't buy anything at all until you've found a
few lemons, and there's money to be made in that market if you can distinguish
between peaches and lemons before anyone else.

So is information asymmetry really just a market opportunity for a savvy
buyer?

~~~
notahacker
> So is information asymmetry really just a market opportunity for a savvy
> buyer?

Of course it can be (the savvy buyer is the one who's not suffering from the
information asymmetry to the same degree) provided you're either not expecting
to resell or expect the information you're acting on to be more widely
available when you resell. If you can reliably identify a particular car
hasn't got a particular issue its model is notorious for by knowing what to
look at, you'll get a better price, assuming at least some people owning
examples of the car without the issue still sell their cars. If you've got a
better risk model, you'll be able to profit from loans other institutions
won't make. If you've got a better hiring process, you'll get staff who will
accept lower wages and stick around for longer because other potential
employers underestimate them.

But not always. If you're in good health and well aware of it, you're still
going to overpay for your health insurance because the insurance company can't
perfectly evaluate your risk (conversely the health insurance is still a good
deal if you're in poor health even if you're entirely ignorant of your
mounting health issues). And sometimes the difference between a lemon and a
peach just isn't going to be evident until after the purchase.

------
mavhc
Buying things on Amazon seems like a similar problem, multiple third parties,
cheapest price, fake reviews or different versions being grouped together
under one set of reviews

~~~
argonaut
Amazon is clearly not a lemon market (and by clearly I mean it's a textbook
case). Amazon is a company that guarantees/warrants the products (buyers have
effective recourse to return products). In the paper's model this prevents a
lemon market.

~~~
mavhc
Still, I feel more and more annoyed using it because I can't trust the
quality. A warranty is still annoying when dealing with low cost items

~~~
aortenzi
I think that the presence of effectively meaningless warranties is ripe for
exposure.

Unlimited replacements for a $40 screen protector? Just send us $20 to ship
you the free replacement.

Business relies on government for enforcement of contract and commercial law,
but simultaneously creates intentionally confusing terms and fights against
the authority of government to enforce the other side (for the consumer).

In addition to the information asymmetry, there's an overall power asymmetry
-- both need to be addressed.

------
skunkworks
The first thought I had when reading this was that this can apply to some
online dating apps.

~~~
thanatropism
It does.

Seriously speaking, asymmetric information and signaling is the one thing that
four-year undergrads in Econ know that's a superpower because ordinary people
don't.

------
weRven0m
"Examples given in Akerlof's paper include the dearth of formal credit markets
in developing countries, and the difficulties that the elderly encounter in
buying health insurance"...may someone please shed some light on these two?

~~~
reitzensteinm
The insurance one is pretty straight forward. Somebody with a history of
shunning insurance that changes their mind may have done it for abstract
reasons (people my age probably should have insurance), or concrete ones (I am
feeling a pain in my chest regularly).

If the latter can avoid being accused of having a pre existing condition, by
avoiding formal diagnosis for some after signing up, they'll be an incredibly
bad deal for the insurance company, and even a small minority of them in the
mix of those seeking insurance will greatly increase costs.

It also applies to anyone ratcheting up their coverage.

So why don't insurance companies ratchet up prices to cover the higher costs?
Because that'll actively filter out the first class of customers, leaving a
higher mix of people that are pretty sure something is wrong with them.

If a decade of fighting cancer costs $5 million, anyone willing to pay $50k a
year for insurance for that almost certainly knows something you don't.

Ad absurdum, you'd end up pricing your insurance at a fixed fee of $5 million
up front, plus profit margin :)

For that reason, companies may just completely opt out of care for that
cohort.

------
wimbledon
I think this applies not only to Markets but also to something like Politics
and Politicians ... "the bad drives out the good."

------
gesman
This theory breaks quickly when seller or buyer needs to do transaction
urgently for many possible reasons.

There was a guy (in a city I used to live) who drove by a Porsche he likes and
asked how much? Lady asked him if he wants to see other cars. It happened that
her husband just died and she wanted to get rid of his estate worth of luxury
cars that she hated. The guy borrowed money from his relatives and ended up
with about dozen of rare/luxury/sports cars for pennies at a dollar.

~~~
throwawaymath
The theory doesn't "break" \- it describes trends and effects which _tend_ to
occur. Examples like yours are not the norm, and the theory allows for
instances where buyers have legitimate reasons for quickly offloading valuable
goods.

------
nsuser3
> [...] Then they are only willing to pay a fixed price for a car that
> averages the value of a "peach" and "lemon" together (p_avg).

So every used car has the same price?

~~~
blowski
No, because there are other factors than whether they are a ‘lemon’ or a
‘peach’. For example, age, mileage, brand value, warranty offered, convenience
of purchase, etc. These don’t tell you whether the car is a lemon or a peach,
although some can help you to guess it.

If you held all these other factors constant, then yes, all used cars would
have the same price.

