Market for Lemons
Market for Lemons Summary “The Market for ‘Lemons’: Quality uncertainty and the Market Mechanism” by George A. Akerlof dives into the economic theories regarding the uncertainty of quality. The article starts off using the new and used car market as an illustration for what it calls “The Lemon Theory”. According to Akerlof, there are really four types of cars, new or used and good or lemon, with lemons as a word for poor quality good or service.
The lemon theory states that as the market evolves over time, more lemons will appear on the market due to customers trying to unload an inferior quality product, in hope to find a better one. As poor quality goods are recirculated and more and more inferior products are brought fresh to the market, high quality goods become harder and harder to find. This poisonous cycle continues endlessly, pushing down market quality. Simultaneously market size is also harmed, as fewer and fewer customers leave happy.
After discussing the auto markets, Akerlof moves to the insurance market. Here he discusses the lack of medical insurance available in the marketplace to customers over the age of +65. As elderly customers have a higher probability of health complications, it makes sense that their premiums would be higher, but why are they nonexistent? The reason, Akerlof suggests, is that because the premiums are so high, only the lemons would be drawn to the policies. These lemons know their own risk of health complication is high, so despite the steep premiums, they stand to gain. Thus, the insurance companies conversely stand to lose, and do not offer such plans to the +65 age group.
From here the article weakly illustrates the theory in the employment of minorities, and even attempts to theoretically quantify the cost of dishonesty in the market place. Things again get interesting when Akerlof discusses the lemon theory in credit markets found in underdeveloped countries, primarily focusing on India. The article found that if
The lemon theory states that as the market evolves over time, more lemons will appear on the market due to customers trying to unload an inferior quality product, in hope to find a better one. As poor quality goods are recirculated and more and more inferior products are brought fresh to the market, high quality goods become harder and harder to find. This poisonous cycle continues endlessly, pushing down market quality. Simultaneously market size is also harmed, as fewer and fewer customers leave happy.
After discussing the auto markets, Akerlof moves to the insurance market. Here he discusses the lack of medical insurance available in the marketplace to customers over the age of +65. As elderly customers have a higher probability of health complications, it makes sense that their premiums would be higher, but why are they nonexistent? The reason, Akerlof suggests, is that because the premiums are so high, only the lemons would be drawn to the policies. These lemons know their own risk of health complication is high, so despite the steep premiums, they stand to gain. Thus, the insurance companies conversely stand to lose, and do not offer such plans to the +65 age group.
From here the article weakly illustrates the theory in the employment of minorities, and even attempts to theoretically quantify the cost of dishonesty in the market place. Things again get interesting when Akerlof discusses the lemon theory in credit markets found in underdeveloped countries, primarily focusing on India. The article found that if