When life gives you lemons...

Once again, we are learning about a case in which one party knows more information in a transaction. Private information is only available to one party in a transaction, which gives the party with the information a huge advantage. This private information leads to asymmetrical information, a concept we learned earlier on in the semester.

The presence of asymmetrical information leads to two things: adverse selection and moral hazard. Adverse selection is the tendency for people to enter into agreements where their private information gives them an advantage. Moral hazard is the tendency for people to act in ways that impose costs on the party without access to the private information. For example, if you pay an insurance company to insure you against theft, then leave your doors unlocked, without the insurance company having knowledge of this.

We seem to focus a lot on the used car market this semester. It is the prime example of a transaction in which one party knows more than another. In the context of used cars, this results in what is known as the lemon problem. Since it is not possible to distinguish between reliable cars and lemons, there are too many lemons and too few reliable cars. We have no way to tell which is which, which gives the seller no real incentive be truthful with us. It’s a 50:50, so a consumer will try to get a lower price due to the risk of ending up with a lemon, but sellers won’t want to see a good car for that low price. The adverse selection here is the greater incentive to offer a lemon. The moral hazard would be that lemon owners have little incentive to care for their cars because we can’t tell either way.

I, like so many of us, have been through the torture of looking for a used car. It’s true, there are definitely more lemons out there and a lot of people trying to rip you off. The best way to avoid this problem is by making sure the car has a warranty, which isn’t always a fix all since sometimes they won’t hold true to their word. I believe Carfax helps people looking for used cars as well. Nevertheless, the situation can be a catch 22 in a lot of ways since we want a good deal, but if the dealer takes that really low offer, does that mean the car has a greater chance of being a complete lemon? I guess it’s just a hit or miss when it comes to getting a lemon or a reliable car. That's why you should always ask a trusted family member i they are looking to get rid of one their cars before hand!


Happy last blog week!