The Market for Lemons - Essay Example

The Market for "Lemons" 1. Article Summary The 1970 article by Akerlof George an economist by profession discussed the way in which a seller was privy to information about a product than a buyer of the same. The core subject that the paper discussed was the information asymmetry while discussing a lemon within the business circle. Ideally, a lemon within the American market is a slang word that refers to a defective car where a buyer realizes this after buying the car. In this paper, Akerlof presented a research on the relationship between quality and uncertainty by using the example of wide market for used cars to draw relevance (Akerlof 488). As per the paper, Akerlof gives the description of a used car, which he gives as the exchange of ownership from a car buyer to a seller after the first owner has used it to a state that may attract wear and tear (489). Asker of intimates that ‘cherries’ and ‘lemons’ are two categories of used cars where by a car attracts these categories depending on the quality of the car and the previous owner’s driving technique. Frequencies of maintenance and vehicle accident history are the other factors that contribute towards a car becoming a ‘cherry’ or a ‘lemon’. With this, this essay will review the article by Akerlof George by giving the summary of the article then discussing the points that he intended to put across. As per this article, a buyer may end up buying a used product without having adequate information concerning the cars history or if it has any hidden defects. During car purchase, a buyer may not have the time to go through all the elements of the vehicle hence making a seller to take advantage of the situation. The implication of this is that the car buyer may not be certain on whether they are buying a ‘cherry’ or a ‘lemon’ as the buyer relies on the general quality of the vehicle and not quality in details. In the end, the average quality assessment that a buyer does influences them to buy it at their chosen value irrespective of whether the car has a good maintenance history or not. Therefore, a buyer or seller may be at a loss as the seller sells the car at a high price as the car deserves or the buyer buys the car at a low price. For this reason, car owners that are sure of the quality of their cars do not sell their cars in the used market for cars as this reduces the average car quality for the vehicles that they intend to sell. On the other hand, the reluctance by good quality used car owners reduces the value of other vehicles in the market hence translating to a reduction of product prices. 2. Asymmetrical information As indicated, quality used cars, tend to receive low value during their sale because of lemons and vice versa. This relatively the bad pushing out the good in a sequence whose dependency is two variables (490). p, is the first variable that denotes the price of the vehicle and the used cars quality presented for trade, or Qd = D (p, p), the supply of lemons and cherries together with their quality on average p will depend on the price (p = p) or (p) and S = S (p). In order for there to be a balance, the supply must equate to the demand of the average quality S (p) =D (p, p(p)). A fall in the price translates to a dip on the quality of the vehicle meaning that sales would most likely not occur. 3. Examples and applications Akerlof’s concept is relatively applicable in the insurance sector as insurance covers are unavailable for those that need it. In essence, older citizens that are at higher risk of getting diseases are not the priority to insures as compared to the dependable population. Insurers aggressively market to the middle age population because their untimely death would translate to a loss of sorts that would require compensation. The population also applies the adverse selection principle in which they may opt to terminate their insurance package in exchange for their premiums as it no longer serves them at their retirement age if they remain healthy (493). This translates to a loss to the insurer as this would leave them with minimal risks to sell to the buyer as they have the option of retaining or terminating their insurance cover. Insurance companies also sell insurance packages to healthy population rather than to the ailing meaning that they also apply adverse selection when choosing the fraction of population that they can cover. This is the reverse because those at higher risks tend to be willing to pay premiums than those with minimal risk, but insurance companies do not give them the opportunity. The same scenario may apply in the casting of minorities within the employment circle as employers tend to discriminate ethnic minorities. This is irrespective of their job capabilities and professional training because of racial prejudice hence making them to miss on expansion opportunities that the potential employee from an ethnic minorities. Another complexity is that a potential employee might have natural talents, but this does not serve as proof enough of their competence unless they go through the educational process (495). Therefore, as much as education attainment may serve as an opportunity for an employee expansion it might also work to the disadvantage of an untrained worker. 4. Conclusion In summary, there are several relevant application for the Akerlof Market for ‘Lemons’ model in showing that quality and uncertainty have a direct correlation within trading. For one, a buyer buys a car not knowing that the car they are buying has a defect hence a seller is the one that benefits from this car sale transaction. Secondly, a seller might be selling a used car that is of good quality but a buyer may assess the vehicle generally without factoring in the strong quality aspects of the same hence offering a lower price than anticipated. Similarly, the double indemnity policy may back fire on insurers if the targeted population opts to trade in their policy for premiums if the policy does not mature because of death. Lastly, an employer may disregard a potential employee because of their racial prejudices hence limiting them from harnessing from their potential. This is because the job seeker might be from an ethnic minority but their professional skills could go beyond their race as they could be in possession of the required training. Therefore, the various application of the Market for ‘Lemons’ in trading have an impact on the economy they may influence an economic phenomenon. Works Cited Akerlof, George. The Market for “Lemons”: Quality Uncertainty and the Market Mechanism. 1970. The Quarterly Journal of Economics Press. Pg 488-500 Read More