Why is buying a good used car a futile proposition
Updated: Apr 12, 2021
The market for lemons is an interesting article that explores the effect of information asymmetry in a sale. Simple day-to-day activities like buying a used car, shopping for health care insurance, hiring a person, etc., involve two parties not under equal footing about the product's quality under sale. The seller of a used car knows more about his car's condition than the buyer. The health insurance shopper has more information about his preexisting conditions than the insurance company. A job applicant has more information about his qualifications than the one who is interviewing him and so on. This information asymmetry presents some interesting responses from the party with lesser information about the product under sale. E.g., a seller trying to wash his hand of a used car that is not working properly will be happy to offer deep discounts, but if his car is good, he will be more likely to hold on to it for a good price. Therefore, the seller's attempt to discount a car’s price will be perceived by the buyer that the car under sale is a lemon. Similarly, a health insurer will perceive that any older person buying his insurance is hiding some preexisting condition. A job applicant from a not-so-good school will be perceived as having questionable qualifications and so on. These actions, though motivated by the lack of complete information about the product under sale, if it occurs every day in society, will manifest as health insurers blocking older adults from insurance, bank manager refusing to give loan to people from distressed neighborhoods, police officers aggressively patrolling minority neighborhoods and job applicants from inner-city schools being refused jobs and so on.
In the end, a free market system that is supposed to be self-regulating with its “invisible hand of the marketplace” hypothesis, that which our leaders sing paeans and gleefully proclaim as the panacea for all our economic and societal woes, breaks down when one party in a transaction has more information about the product under sale than the other.