The Market For “Lemons”:

Quality Uncertainty and the Market

Mechanism (George A. Akerlof)

GROUP 5:
- Desi Kartika
- Mayang Wulandari N.P.
- Theodorus Pandhu Bhaskoro P.
 Introduction

Keypoint: Quality, Uncertainty, Asymmetric Information →

important institution of labor market
● how prices can determine the quality of goods traded on the
market
● how the quality of goods traded in a market can degrade in the
presence of information asymmetry between buyers and
sellers
● Low prices drive away sellers of high-quality goods, leaving
only low behind

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 The Model with automotive market

● Akerlof's paper uses the market for used cars as an example of the problem of
quality uncertainty. In American slang, a lemon is a car that is found to be
defective only after it has been bought.
● The problem of asymmetrical information arises because buyers and sellers don't
have equal amounts of information required to make an informed decision
regarding a transaction
● It concludes that owners of high-quality used cars will not place their cars on the
used car market. A car buyer should only be able to buy low-quality used cars, and
will pay accordingly. The market for good used cars does not exist

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 EXAMPLES & APPLICATIONS
1. The difficulties for the elderly to find medical insurance
Lemons Model to the health insurance industry (adverse selection)
Health insurance companies are cautious when it comes to insuring older people or people
that are more prone to get sick (to use the author’s terminology, lemons) →
a. screen customers to eliminate high medical users
b. establish coverage limits and increase premiums to cover perceived financial risk

In these ways, information asymmetry contributes to :

the health system’s high absolute costs, high administrative costs, its large uninsured
population and the inability of people to afford needed care.

According to Akerlof, this is an argument in favor of government intervention in health

care.

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 EXAMPLES & APPLICATIONS
2. Labor market discrimination of minorities
Lemons Principle on the employment of minorities
The inability of minorities to secure decent employment prospects.
Employers may refuse to hire employee of minority groups in responsible positions →
it’s difficult to distinguish those with good job qualifications from those bad
qualifications.

According to Akerlof, this decision may not reflect irrationality or prejudice, but profit
maximization. For race may serve as a good statistic for the applicant’s social background,
quality of schooling, and general job capabilities.

An untrained worker may have valuable natural talents, but these talents must be certified
by “the educational establishment” before a company can afford to use them.

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 EXAMPLE & APPLICATIONS
Credit Market in Underdeveloped Country
1. entrepreneurs have to turn to managing agencies people and
companies with reputation and communal influence, for
financing a newly started firm

2. rural credit market is dominated by loans with extortionate

rates from local moneylenders rather than those with official
rates formal bans since only the former have good access to
borrower’s information. anyone who try to arbitrage tend to
lose.
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 Counteracting institutions:

1. Giving guarantee for durable goods

2. Brand-name goods and chains
3. Licensing practices
4. All aim to reduce information asymmetry

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THANK YOU