George Akerlof, Milton Friedman, and Moroccan Lemons

The American Economic Association annual meetings are going on right now. Once a year about 10,000 economists all descend on a city (never Las Vegas because not enough economists gamble), give seminars to one another, and interview the newest crop of Ph.D. students to determine who will get jobs where.

The events at these meetings are not generally very newsworthy. This year, though the New York Times has an article about George Akerlof’s presidential address to be given today. Akerlof, the article says, will encourage economists to build more reality into economics. By reality, Akerlof means quirkiness in the way that people make decisions, in contrast to the “rational man” type of assumption that, say, Milton Friedman would have embraced. Indeed, the article paints Akerlof and Friedman as reflecting opposite poles. This isn’t quite right, though. Both Akerlof and Friedman want to explain real world phenomena and their work aims squarely at doing so. Many economists, in contrast, care little about real-world questions. In this important regard, I see Akerlof and Friedman as being on the same team rather than opposing teams.

More amusing than the article itself is the advertising links that accompany it. When you do a search on Akerlof’s name in the New York Times database, along with the search results, you get a list of related ads that are generated by Google to entice the people who are searching for stories on Akerlof’s to buy some associated products. The uninitiated might be puzzled why searching for an economist would get you links to buying lemons from Morocco. The answer: one of George Akerlof’s important economic contributions was a paper on information asymmetry entitled “The Market for Lemons.” (This paper wasn’t about the lemons you eat, of course, but rather about low quality used cars that people describe as lemons.)


G.V.Varma

"Market for Lemons"explains information asymmetry from the buyers side.Sometimes this can occur from the sellers side also.For example, in India there are many pavement second-hand book sellers sitting comfortably below some big banyan or some other shady trees and who do not know the quality of the book he sells while the buyer perfectly knows the quality of the book.So you can buy, for example, a second hand copy of Samuelson's "Foundations" at a throw away price.

pkimelma

I do not see how the Akerlof vs. Friedman model were ever really that different. As far as I have understood it, the Akerlof model focuses on the consumer not being able to get at information. That is, when they have access to information, they make good decisions. When they have not enough information, most make assumptions of lowered quality and so destroy the market for the good products (since devalued by the assumption). Finally, a few are uninformed by choice (do not care) and so buy poor quality anyway. Friedman really focused on the "average" and ignored the two extremes. In normal markets (where consistency is counted on), both models match well. They only split in markets where consistency is broken (used cars is one good example).
This raises the question of whether the internet (a source of information far stronger and more widely available than any that preceded it) has changed things such that the two models converge more. Ignoring shilled sites and spam (pushing junk stocks), it would seem the internet has actually enhanced the disparity Akerlof focused on. That is, used cars will remain a mystery, even with Carfax, you still have almost no information on the quality of the car. But, new goods and services (e.g. insurance and mortgages) are easily compared, such that you have more sources of information than ever before: professional such as consumer reports, complaints to regulators, other consumers reviews, analytical comparison systems, out of local area access, etc. So, any who wish to be informed can do so with almost no barrier to entry. Therefore there are likely less who are uninformed by choice or lack of access (in the past, the salesman was likely the main source of information for almost everything). It is easier to be a rational consumer when the barrier to that rationality is very low.
Am I missing something?

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G.V.Varma

So second hand foot path book-market in India operates in sharp contrast to the "Lemon Market Theory" propositions.It is generally flooded with good quality books.

pkimelma

G.V.Varma, how did the bookseller acquire the book? He/She must have been a buyer previously? So, the asymmetry existed at the wholesale/lot level. However, that means that the seller of the book at that level did not know what they have. This occurs in estate sales and other cases where you have "motivated" sellers who just want to unload goods, and so no market price is established (often the price is based on weight or just straight count).

G.V.Varma

pkimelma,
One reason may be the inability to classify books in different subjects according to quality.Even if the seller has knowledge regarding the quality of the books in one subject, in other subjects he fails to make a quality-wise price-fixation.So a confusion exists in sorting out the lemons.But in big cities like Bangalore, there are educated (mostly retired employees)old book sellers running small shops, who price their books according to quality and scarcity and their shops (because of their own full knowledge) is filled with quality second hand books .There are no lemons.An example of such a book shop is "Select Book Shop" off Brigade Road ,Bangalore (they are not pavement sellers, they have their own establishments, however small it may be).

pkimelma

G.V.Varma, my point is that these are re-sellers. That is, these booksellers are not manufacturers, but selling a good they purchased from someone else. The pavement sellers normally buy their books from estate sales and other second hand markets. So, they do not "need" to price their goods, since they were priced for them (the wholesale price if you will); they presumably use a fixed margin in general. The shopkeepers are "informed consumers" when they buy the books 2nd hand (whether point purchases or lots) and informed sellers when they sell them; they get higher margins on some books.
You are right that a bookseller buying a used book from someone may fit Akerlof's asymmetry in reverse (the buyer has more information than the seller). But, I do not think it follows the rest of the model. That is, I do not think the seller assumes they are being misinformed and so makes valuation decisions that affect the overall market (as they are in something like used cars). For one, a private seller has access to information on real market value if they choose to pursue it. The problem with used cars is that there is great variability in individual cars (even from same model and year) due to how they were cared for and known problems. Only the seller knows that information and so the buyer is an information disadvantage. Knowing this, buyers tend to assume cars are in worse shape, so damaging the market for good used cars.

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G.V.Varma

pkimelma,
I agree with your points.But there are so many minute issues involved in a second hand book market.Estate sale ,for example is not so prevalent in India. Your statement "The problem with used cars....were cared for and known problems" is applicable in old books also.There is great variability in individual editions of the same book; some copies due to careless or vigorous use will have torn and marked pages; some other copies will be not only carefully read but well maintained by a reader who is adhered to neat handling habits so that the book appears quite new and first hand (individual traits of the readers affects the physical quality of the book-the "how they were cared" issue pointed out by you in your comment regarding used cars).Moreover a pavement seller or even a wholesaler of second hand books cannot distinguish between qualitatively similar books, for example an old copy of Mankiw's or Gordon's or Abel and Bernanke's macroeconomics text book.I purchased Lucas and Sargent's "Rational Expectations and Econometric Practice" from a Mumbai footpath book seller for just RS.10 ( less than $0.48).Therefore in many instances, due to buyer's superior position and perfect knowledge, they can gain a sizable consumer's surplus in second hand book market and my point ,as you have rightly indicated in your comment, was to show the possibility of a reverse information assymmetry.

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Princess Leia

oh come on, Steve, give us the real dish on what's going down at the AEA Convention: what are they serving at the cocktail parties? anyone with good shoes? and perhaps most importantly, who's sleeping with whom???

it's a fairly boring Saturday night and we the masses want to know!!! also, please say hi to my other economist friends for me. :-)

Princess Leia

my comment is awaiting moderation? when did that start.

i hate the idea of my being censored. :-(

pkimelma

G.V.Varma, I agree that many sellers do not know the market value for a particular book (especially outside of their specialty, if they have one), but quality of the book condition seems very apparent and easily discerned. With cars (as an example), you have the problem that it is very hard to discern without specialized knowledge and tools. But, a quick flip through a book allows for quick evaluation of condition (with the exception of a carefully removed page, which would not be easy to detect, but is rare).
So, the asymmetry comes in two parts: that which is categorical and that which is about the individual item. For most things, the categorical value can be researched (easy or easier with the internet), including books. The individual condition is easy with many things and can be very hard with others. Antiques and paintings are examples of hard to detect individual items due to fraud (reproductions). Used cars and electronics and real estate can have "hidden" problems that are hard to detect. But, most other things can be determined from the outside without more than consumer's knowledge. I would have thought that books fall into that latter category (inspection is enough for the individual).

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bee

The models offered by Akerlof (Lemons) and Friedman have many similarities and a few differences. Both employed mathematical formalization to characterize their theories. Both modeled market-level behavior. Both made individual-level assumptions about actor behavior.

Where the two models differ most significantly is that Akerlof focused on a factor that led to market failure (I hate the word/concept given our current state of knowledge) while Friedman's model focused on macro market clearing. In addition, Friedman was primarily concerned with aggregate market behavior. The Friedman model does a fair job in showing market clearing behavior in aggregate. The model does not suggest or offer what factors would lead to failure. The Akerlof was primarily concerned with information asymmetry and its impact. This model allows one to see how information asymmetry adversely impacts the market. It does, however, reduce all failure to information asymmetry (a part from specified parameters). We collapse into a general concept information
Motivations and attitudes are not formally captured.

In summary, I think that Akerlof should have offered his model as well in his paper.

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bee

pkimelma your example of buyers superior information is a good one (knowing value of book). It shows that Akerlof narrowly specified information in his model (as well as the nature of asymmetry- buyer vs. seller). Price setting is a function of many different types of information. Quality is just one form. A market maker is taking advantage of more than quality. A logical extension to Akerlof's model would be to extend information types in the specification.

We could alternatively frame Akerlof's model as an Agency-Principle problem or as a Game. In this way we are looking just at actors not markets.

G.V.Varma

bee,6.40 pm,
Buyer's superior information about the quality of the books in the second hand book market is my argument so that such a market, atleast in India, is flooded with good quality books.There is reverse assymmetry.My point of argument is what you have said ,that is, Akerlof narrowly specified the nature of asymmetry.

pkimelma

G.V.Varma, to be fair, Akerlof was focusing on information asymmetry as it affects market pricing of certain kinds of goods. In particular, the buyers will tend to assume lower quality when they do not have the information, and so push the market towards lower quality (since the higher quality item will not be able to get its intrinsic value due to these assumptions). He was not commenting on the reverse asymmetry per se.
Your example of sellers will little information is an interesting one, but is made partly artificial by the way that the sellers obtain the goods. As I said before, I think you have to really look at how the street vendors are obtaining those books, since there must be "ignorance symmetry" at that point (buyer and seller both lack information).

G.V.Varma

pkimelma,
You are absolutely correct.I hope somebody will develop these ideas in to a theory with due acknowledgement to us.

dg

Princess Leia Says:
January 7th, 2007 at 12:36 am
oh come on, Steve, give us the real dish on what's going down at the AEA Convention: what are they serving at the cocktail parties? anyone with good shoes? and perhaps most importantly, who's sleeping with whom???

Princess,
I just came back from the AEA meetings and I assure you that no one is sleeping with anyone. We're economists after all.

I did hear a story about an AEA conference a number of years ago in which a prostitute was overheard complaining that economists don't want to spend money.

G.V.Varma

"Market for Lemons"explains information asymmetry from the buyers side.Sometimes this can occur from the sellers side also.For example, in India there are many pavement second-hand book sellers sitting comfortably below some big banyan or some other shady trees and who do not know the quality of the book he sells while the buyer perfectly knows the quality of the book.So you can buy, for example, a second hand copy of Samuelson's "Foundations" at a throw away price.

pkimelma

I do not see how the Akerlof vs. Friedman model were ever really that different. As far as I have understood it, the Akerlof model focuses on the consumer not being able to get at information. That is, when they have access to information, they make good decisions. When they have not enough information, most make assumptions of lowered quality and so destroy the market for the good products (since devalued by the assumption). Finally, a few are uninformed by choice (do not care) and so buy poor quality anyway. Friedman really focused on the "average" and ignored the two extremes. In normal markets (where consistency is counted on), both models match well. They only split in markets where consistency is broken (used cars is one good example).
This raises the question of whether the internet (a source of information far stronger and more widely available than any that preceded it) has changed things such that the two models converge more. Ignoring shilled sites and spam (pushing junk stocks), it would seem the internet has actually enhanced the disparity Akerlof focused on. That is, used cars will remain a mystery, even with Carfax, you still have almost no information on the quality of the car. But, new goods and services (e.g. insurance and mortgages) are easily compared, such that you have more sources of information than ever before: professional such as consumer reports, complaints to regulators, other consumers reviews, analytical comparison systems, out of local area access, etc. So, any who wish to be informed can do so with almost no barrier to entry. Therefore there are likely less who are uninformed by choice or lack of access (in the past, the salesman was likely the main source of information for almost everything). It is easier to be a rational consumer when the barrier to that rationality is very low.
Am I missing something?

Read more...

G.V.Varma

So second hand foot path book-market in India operates in sharp contrast to the "Lemon Market Theory" propositions.It is generally flooded with good quality books.

pkimelma

G.V.Varma, how did the bookseller acquire the book? He/She must have been a buyer previously? So, the asymmetry existed at the wholesale/lot level. However, that means that the seller of the book at that level did not know what they have. This occurs in estate sales and other cases where you have "motivated" sellers who just want to unload goods, and so no market price is established (often the price is based on weight or just straight count).