Market for Lemons Revisited Featured

By Ted Craig July 31, 2019 1833

I don’t have a Noble Prize, or even a Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel, but I always questioned George Akerlof’s “Market for Lemons” hypothesis. Akerlof did win the Noble in economics for this in 2001. The main idea is that used-car prices are driven down because the buyers distrust the sellers. The sellers, the paper argues, know more about the cars than the buyers and the buyers assume that includes knowledge of problems with the cars. This is called “asymmetric information.” It does not mean, as some halfwit once said online, that “George Akerlof (won) a Nobel Prize for explaining why it's difficult to buy a decent used car.” Akerlof didn’t say the cars actually were lemons, only that buyers perceived them to be. And the issue has been solved somewhat today via certified programs and vehicle history reports, which are part of the reason more traditional new-car buyers are switching to used.

But there are other reasons for the switch and one of them is, in my opinion, a better explanation for the price differentiation between new and used cars than asymmetric information. There is another economic principle called signaling. It means people will make purchase decisions to signal their status. For many people, this means buying new. This is true for many items, including cars. For example, the economist Arnold Kling once found that a strong correlation between purchases and affluent ZIP codes was the purchase of new books. New cars were long a status symbol, but that has diminished somewhat and many middle-class consumers are making other financial choices, such as opting for the ability to send the right-colored texts rather than spending that money on a new car.

Another failure of Akerlof’s theory is he puts the emphasis on the wrong word. “Market” is more important than “lemons.” Used cars are a much purer market than new cars. Consumers are meeting their transportation needs, not their signaling needs. The sellers are driven by the profit they can make on that sale, not what they need to pay for millions of current and retired auto workers. There are fewer price distortions, like incentives and 0-percent financing.

Finally, the data since 1970, when the Market for Lemons” was published, doesn’t really seem to support Akerlof either. But again, what do I know. I’m not as brilliant as a Noble-winning economist.

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Last modified on Wednesday, 31 July 2019 16:11