Market for Lemons

Essay Questions #5
Name
Professor Morey
Spring 2022
1 Why do markets fail if there is a Market for Lemons? Use the used car example.
A market for lemons is a situation whereby sellers are more knowledgeable about the quality of the product than buyers. Therefore, this information asymmetry enables the market to experience quality uncertainty and market mechanisms whereby high-quality goods could be withdrawn from the market, leaving lower quality goods that eventually lead to market failure. For instance, in George Akerlof’s case of used cars, where sellers are more informed about the quality of the car than buyers, they understand all the strengths and weaknesses concerning the car than the buyers. Thus, the information difference between the seller of the car and the buyer creates quality uncertainty that eventually destroys the market of the used cars and opportunities for the profitable exchange of the used cars.
2 Explain the market for lemons in labor markets, health care, and free agents in baseball.
Labor markets.
The market for lemons in the labor markets is experienced when the employees or workers have confidential information on their ability and their intrinsic motivation for the job provided by the firm in the labor market. For instance, high salaries may attract more skilled but less motivated candidates, or more skilled and motivated candidates, or rather less skilled and less motivated candidates both in a firm.
Health care.
In the healthcare sector, the market for lemons is often experienced between the doctor and the patient or the patient and the insurance company. In the first case, large numbers of patients in a hospital can be overwhelming. Thus, the doctor may recommend all the patients follow a particular diet carefully to yield better results. Nevertheless, a problem arises if only a few can do that, while the rest are exposed to a higher risk of contracting the disease due to a lack of motivation. Therefore, the inability of doctors to judge a patient’s motivation may consider that all patients have average motivation, which clears out diet. Gradual guidelines are conducted, then opt for the patients with the lowest motivation, "lemon"; hence drugs are recommended.
Free agents in baseball.
In this case, the market for lemons is experienced between the clubs where players have performed and those that the players have not performed. The former has more helpful information to estimate the players' future performance than the latter that has not employed the player. Similarly, free agents tend to stay longer on the disabled list than the non-free agents, and over time, club owners tend to change their expectations towards the free agent’s performance.
3 Explain the market for lemons in banking and finance (there are at least 2)
Just like other markets, the banking and finance market also experiences information asymmetry in the following ways;
a) Adverse selection.
Similar to the case of used cars, adverse selection in banking and finance operates the same way whereby consumers will have superior information than the bank. Regardless of the size of the loan, consumers are the only ones who understand their spending habits and the natures of thei...