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Friday, December 23, 2005

Lemon problem

This problem was noted byAkerlof in 1970. A popular example of the phenomenon is in the secondhand car market, where sellers know whether or nor their car is a lemon (i.e perform badly), but where buyers cannot make that judgement without running the car. Given that buyers can't tell the quality of the car they are buying, all cars of the same model will end up selling at the same price, regardless of whether they rae lemons or not. But the risk of purchasing a lemon will lower the price buyers are prepared to pay for any car and, because secondhand prices are low, people with non-lemon cars will be little inclined to put them on the market.
This problem is commonly referred to as an adverse selection.

6 comments:

Anonymous said...

Maruthi "TRUE VALUE" has come with a solution to this problem partly, in India, with reconditioned cars, with one year guarantee. Thus creating a Marketplace for secondhand cars and with theoretical true pricing.

Murali K. said...

Maruthi "TRUE VALUE" has come with a solution to this problem partly, in India, with reconditioned cars, with one year guarantee. Thus creating a Marketplace for secondhand cars and with theoretical true pricing.

Shripal Meghani said...

An interesting area where the Lemon Effect manifests itself is in Venture Capital. Startups approaching VCs for funding may often be lemons, but due to the information asymmetry, the VCs dont know that. Infact due their previous experience with similar "lemons" might cause them to consider even good investments as bad.

alex said...

Shripal,

Thanks for the insight.

gautam said...

i m doing BA from st john college agra.i want to do post graduation in economics from reputed institution.but ther is problem i dont have nmaths at 12 level&undrgraduatelevel

Buky said...

Hi,
thanks for explaining this.
I needed it from my Economics Exam :)
xoxo