Market for Lemons by Akerlof - Book Report/Review Example

This year's Laureates proposed a common explanation and extended the theory when they augmented the theory with the realistic assumption of asymmetric information: agents on one side of the market have much better information than those on the other side. Borrowers know more than the lender about their repayment prospects; the seller knows more than buyers about the quality of his car; the CEO and the board know more than the shareholders about the profitability of the firm; policyholders know more than the insurance company about their accident risk; and tenants know more than the landowner about their work effort and harvesting conditions.

More specifically, Akerlof showed that informational asymmetries can give rise to adverse selection on markets. Due to imperfect information on the part of lenders or prospective car buyers, borrowers with weak repayment prospects or sellers of low-quality cars crowd out everyone else from the market. Some claim that Aker. Due to imperfect information on the part of lenders or prospective car buyers, borrowers with weak repayment prospects or sellers of low-quality cars crowd out everyone else from the market.

(Nobel Prize.org 2009, p. 1) Some claim that Akerlof's essay, "The Market for Lemons" is the ultimate representation of study in the economics of information literacy. It has both seminal features in that it describes something simple but profound, has a significant number of implications and applications that are widespread in nature. Akerlof starts out by describing a formal analysis-the first of its kind-of markets that suffer from adverse selection. "He analyses a market for a good where the seller has more information than the buyer regarding the quality of the product.

This is exemplified by the market for used cars; "a lemon" - a colloquialism for a defective old car - is now a well-known metaphor in economists' theoretical vocabulary. Akerlof shows that hypothetically, the information problem can either cause an entire market to collapse or contract it into an adverse selection of low-quality products." (Nobel Prize.org 2009, p. 1). Akerlof also points out other information asymmetries. Most of these appear to him in developing countries. For example, in India, in the 1960s, urban lenders chose to charge twice as much interest as those who operated in the larger cities.

Another example occurs when Akerlof describes health insurance for the elderly. Yet another is discrimination of certain groups of people in the labor market. "A key insight in his "lemons paper" is that economic agents may have strong incentives to offset the adverse effects.