The Market for Lemons

"The Market for Lemons: Quality Uncertainty and the Market Mechanism" is a paper by George Akerlof written in 1970 that established the fundamentals of asymmetrical information theory. Akerlof, a professor at the University of California, Berkeley, won the Nobel Prize of Economics in 2001 for his research.

Related Topics:
George Akerlof - 1970 - Asymmetrical information theory - University of California, Berkeley - Nobel Prize of Economics - 2001

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The paper by Akerlof describes how the interaction between quality heterogeneity and asymmetrical information can lead to the disappearance of a market where guarantees are indefinite.

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In this model, as quality is undistinguishable beforehand by the buyer (due to the asymmetry of information), incentives exist for the seller to pass off a low-quality good as a higher-quality one. The buyer, however, takes this incentive into consideration, and takes the quality of the good to be uncertain. Only the average quality of the good will be considered, which in turn will have the side effect that goods that are above average in terms of quality will be driven out of the market. This mechanism is repeated until a no-trade equilibrium is reached.

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As a consequence of the mechanism described in this paper, markets may fail to exist altogether in certain situations involving quality uncertainty. Examples include the market for used cars, the dearth of formal credit markets in developing countries and the unavailability of health insurance for the elderly (that is, in the absence of government programs such as Medicare (United States)).

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