Saturday, April 29, 2006

Adverse Selection (or "Why you can never buy a decent used car")

In 1966, Georgee Akerlof wrote a paper titled "The Market For Lemons", which was published in the Quarterly Journal of Economics in 1970 and eventually led to his getting the Nobel Prize. The paper demonstrates how differences in information between buyers and sellers can cause problems in a market.

This concept (known as "asymmetric information") has had far-reaching applications. Just a few of the areas it where it shows up include the markets for goods, the problems faced by lenders or insurers, and the effects of securities issuances or dividend changes.

Tim Harford (author of The Undercover Economist) has a nice piece that explains the basics of this perspective in Slate Magazine titled Why you can never buy a decent used car.

In addition, here's an essay Akerlof wrote with some refletions on writing and eventually getting the article published.

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