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Lemons problem and its effects on the efficient functioning of a market - Essay Example

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The problem tackles how horse traders answer to the natural question: "if he, or she wants to sell a horse, do consumers truly want to purchase it?" Such questioning is essential to the market for used cars and…
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Lemons Problem and Its Effects on the Efficient Functioning Of a Market Definition of Lemons Problem The lemons problem deals with issues as old as markets themselves. The problem tackles how horse traders answer to the natural question: "if he, or she wants to sell a horse, do consumers truly want to purchase it?" Such questioning is essential to the market for used cars and horses, but it is also, in any case, minimally present in every market operation (Mishkin 420). The problem was recognized by economist George Akerlof by a 70’s research paper. The term is founded on Akerlofs expression of the concept of asymmetric information by the examples of defective used vehicles, which are referred to as lemons in the marketplace. The lemons problem, in the investment field, is noticeable in areas such as corporate finance and insurance (Mishkin 420).
Importance of the Lemons Problem
The lemons problem is essential in business as it clarifies those who are overexploited, in business dealing, and those who are not (Akerlof 1). Information asymmetry occurs when parties to a transaction lack the same degree of information essential to formulate an informed decision. For instance, in the market for used vehicles, the purchaser mainly cannot establish the value of a car accurately and might, therefore, just be willing to pay a minimal price for the car (Akerlof 1). This is somewhere between the premium price and the bargain price (Mishkin 434). Nevertheless, this tilts the proceedings in favor of a lemon vendor. This is because, even as the normal price for this lemon would be higher than the value it would command, the purchaser knew beforehand that it was, in fact, a lemon (Mishkin 435). Also, such a happening puts the seller of a proper used car at a disadvantage, as the best price a vendor can expect is an average price, but not the premium price the vehicle should command.
Works Cited
Akerlof, George. Writing the "The Market for Lemons": A Personal and Interpretive Essay. N.p, 2001. Web. Mishkin, Frederic. Economics of Money, Banking and Financial Markets (10th ed.). Upper Saddle River, New Jersey: Prentice Hall, 2012. Print. Read More
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