Assignment 01

Sadaf Iqbal BBA-17-08

Lemons Problem and Its Effect on the Efficient Functioning

of a Market a theory by George Akerlof.
George Akerlof, along with Michael Spence and Joseph Stiglitz, received the 2001 Nobel Prize
“for their analyses of markets with asymmetric information.”

His Contribution: Studied markets where sellers of products have more information than buyers
about product quality. According to him low-quality products may squeeze out high-quality
products in markets, and the prices of high-quality products may suffer as a result. Although
much of economics is based on the assumption of perfect information, various economists in the
past had considered the effects of imperfect information.

"The Market for Lemons" and asymmetric information

Akerlof is perhaps best known for the article, "The Market for Lemons: Quality Uncertainty and
the Market Mechanism", which was published in Quarterly Journal of Economics in 1970
Akerlof identified some severe problems that afflict markets characterized by asymmetric
information. Akerlof gave an explanation for a well-known phenomenon which is ‘the fact that
cars barely a few months old sell for well below their new-car price’ Akerlof’s model was simple
but powerful. Assume that and some cars are high quality and some cars are lemons if buyers
could tell which cars are lemons and which are high quality then there will be separate 2 markets
 Assignment 01
Sadaf Iqbal BBA-17-08
 a market for lemons
 a market for high-quality cars
But there’s an asymmetric information: buyers cannot tell which cars are lemons but the sellers
know. So a buyer has knowledge that there is some probability that the car he buys will be a
lemon and is willing to pay less than he would pay if he were certain that he was buying a high-
quality car. This lower price for all used cars discourages sellers of high-quality cars. Although
some would be willing to sell their own cars at the price that buyers of high-quality used cars
would be willing to pay, they are not willing to sell at the lower price that reflects the risk that
the buyer may end up with a lemon. Thus, exchanges that could benefit both buyer and seller fail
to take place and efficiency is lost.

Akerlof didn't conclude that the lemon problem essentially suggests a function for government.
But instead, he called attention to that some unregulated economy foundations can be viewed as
methods of settling or lessening "lemon problems." One solution that Akerlof noted is
guarantee/warranty, in light of the fact that these give the purchaser confirmation that the vehicle
isn't a lemon, and the purchaser is accordingly ready to pay more for the vehicle with a
guarantee. Additionally, the dealers who are eager to offer the warranty are the individuals who
are sure that they are not selling a lemon. Another market arrangement that has tagged along
since Akerlof's article is Carfax, an extremely low-cost method of discovering a vehicle's set of
experiences of fixes. Akerlof likewise went past cars and indicated that similar sort of issues
emerge in credit markets and medical coverage markets.
 Assignment 01
Sadaf Iqbal BBA-17-08

References:
1. George A. Akerlof – Facts. NobelPrize.org. Nobel Media AB 2020. Tue. 8 Dec 2020.
https://www.nobelprize.org/prizes/economic-sciences/2001/akerlof/facts/
2. The library of economics and liberty
https://www.econlib.org/library/Enc/bios/Akerlof.html
3. Wikipedia
https://en.wikipedia.org/wiki/George_Akerlof#%22The_Market_for_Lemons%22_and_a
symmetric_information