Topic 2 Paper: (Akerlof 1970)

Question 1

Summerise Akerloff’s paper, ‘The Market for Lemons’

Answer 1

Carved out the theory of adverse selection, where the inability of one side of a market to determine the quality of individual goods/services on the other, results the quality goods/services on the market being lowered, or the market collapsing. Considers applications in insurance, employment and the developing world.

Question 2

What is the effect that causes Lemon Markets called?

Answer 2

Adverse Selection

Question 3

What are the two properties that define lemon markets?

Answer 3

• Variable quality in goods/services

- Asymmetrical information about that quality

Question 4

What is the result of a Lemon Market?

Answer 4

Bad sellers ‘drive out’ some or all of the good sellers

Question 5

What is the result of adverse selection in insurance?

Answer 5

Unhealthy individuals are drawn to high coverage plans, this necessitates an increase in premiums which will drive out healthy individuals and raise insurance costs (for the insurer) further

Question 6

Where does Akerloff see elements of ‘Lemon Markets’ in the real world?

Answer 6

• Not necessarily in the market for used cars
• In the developing world,
  
  • quality assurance for exports
  • high interest money lenders who know their clients personally
• market for insurance
• employment of minorities

Question 7

Does Akerloff see any possibility to counteract adverse selection?

Answer 7

Yes

• Guaranties
• Brand names / Chains
• Signalling of various sorts