Angel J. Zapata Rubio |
Today I’m going to talk about market failures,
more precisely, about problems raised by differences in information between
buyers and sellers.
Usually and for simplicity, economists start
studying a market as if the people involved are perfectly aware of everything
inside it. All share the same information (They know the quality of the good,
the supply, the demand, the price...). An individual is capable of making the
right pick whenever faced with two similar goods, and this state is called a
perfectly competitive market.
Unfortunately, in real life things don´t work
out so easily for everyone. Information is costly to obtain, or in certain
circumstances, impossible, so we get to the obvious conclusion that the parties
involved in a transaction never, or almost never, (just to be safe) have the
same information of the product sold. Normally the seller always has some extra
information about the product (since he is more familiar with it, or he is the
one producing it), that he may not be interested in sharing with the buyer.
To make the argument clearer, I will proceed
with a famous example: The market for lemons
(‘’the market for lemons: Quality
Uncertainty and the market Mechanism’’, the Quarterly Journal of Economics, 84,
1970, pp. 488-500)
In this example, we have a market with 100
people who want to sell their used cars and 100 people who want to buy a used
car. Everyone knows there are 50 plums (good car) and 50 lemons (bad cars). But
only the current owners of the vehicles know the quality of their own cars. The
owners of plumbs will be happy selling them for 2000, and the owners of lemons,
for 1000. In the other hand, the buyers are willing to pay 2400 for the plumbs
and 1200 for lemons. If there was no problem knowing the quality of the car,
the lemons would be sold at a price between 1000 and 1200 and the plums between
2000 and 2400. But since buyers don´t Know the quality of the car; they will be
willing to pay for any car, its expected value
0,5x1200 + 0,5x2400= 1800.
The problem comes when we think about who will
be willing to sell their car at that price, the answer is that the owners of
the lemons certainly would, but the owners of the plums wouldn´t. In this case
scenario, none of the plums get sold, even if the buyers are willing to pay
2400 in the first place.
The source of this market failure is that there
is an externality between the sellers of good cars and bad cars. If the owners
of bad cars decide to sell them, they will bring a negative impact to the
owners of the good cars, since the average of the quality of the cars in the
market; together with the price buyers are willing to pay for used cars go
down.
In the end, the fact that someone is offering
to sell his/her car gives a negative signal about the quality of the car so it
makes it really hard to high quality cars to be sold.
This conclusion leads to another economic
issue, signalling, which is one way of solving the problem of asymmetric
information. Sellers of a particular product will try to demonstrate or prove
to buyers how their good is better than the rest.
In the example of cars, the owners of plum cars
can offer buyers to test the car before buying it. By doing this they make sure
the buyer knows the car is a high quality car, and therefore he will be willing
to buy it for the real price of a plum car.
The example of `the lemon market´ can be
applied to any competitive market on which firms are competing for quality
instead of quantity.
By the way, there is a very funny reference to
this lemon market example on the 8th chapter of the 1st
season of ‘How I met your mother’ for those of you that like this sitcom.
Genial! Tendré que ver ese capítulo. Empresas del mundo quedaros con este nombre Angel Zapata :-)
ResponderEliminarMuy ilustrativo este artículo.
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