Quality Uncertainty and the market for lemons a The market for Used cars Assume e Buyers and sellers can distinguish between high and low quality cars ◆ There wi‖ be two markets Chapter 17 Slide 6
Chapter 17 Slide 6 ◼ The Market for Used Cars ⚫ Assume ◆Buyers and sellers can distinguish between high and low quality cars ◆There will be two markets Quality Uncertainty and the Market for Lemons
The Lemons problem The market for high and low With asymmetric information buyers will quality cars when buyers and sellers find it difficult to determine quality. They lower can identify each car their expectations of the average quality of P used cars. Demand for low and high quality d cars shifts to d se in Q reduces expectations and 10000 demand to DLM. The adjustment process continues until demand= DL. D H 5.000 D 25.000 50.000 50.000 75.000 Q
The Lemons Problem PH PL QH QL SH SL DH DL 5,000 50,000 50,000 The market for high and low quality cars when buyers and sellers can identify each car 10,000 DL DM DM 25,000 75,000 With asymmetric information buyers will find it difficult to determine quality. They lower their expectations of the average quality of used cars. Demand for low and high quality used cars shifts to DM . DLM DLM The increase in QL reduces expectations and demand to DLM. The adjustment process continues until demand = DL
Quality Uncertainty and the market for lemons The market for Used Cars o With asymmetric information Low quality goods drive high quality goods out of the market The market has failed to produce mutually beneficial trade Too many low and too few high quality cars are on the market Adverse selection occurs, the only cars on the market will be low quality cars Chapter 17 Slide 8
Chapter 17 Slide 8 ◼ The Market for Used Cars ⚫ With asymmetric information: ◆ Low quality goods drive high quality goods out of the market. ◆ The market has failed to produce mutually beneficial trade. ◆ Too many low and too few high quality cars are on the market. ◆ Adverse selection occurs; the only cars on the market will be low quality cars. Quality Uncertainty and the Market for Lemons
Implications of Asymmetric Information The Market for Insurance ■ Medical Insurance Question ols it possible for insurance companies to separate high and low risk policy holders? o If not, only high risk people will purchase Insurance Adverse selection would make medical insurance unprofitable Chapter 17 Slide 9
Chapter 17 Slide 9 Implications of Asymmetric Information ◼ Medical Insurance ⚫ Question ◆Is it possible for insurance companies to separate high and low risk policy holders? ⚫ If not, only high risk people will purchase insurance. ⚫ Adverse selection would make medical insurance unprofitable. The Market for Insurance
Implications of Asymmetric Information The Market for Insurance ■ Automobile Insurance Questions .What impact does asymmetric information and adverse selection have on insurance rates and the delivery of automobile accident insurance? How can the government reduce the impact of adverse selection in the insurance industry? Chapter 17 Slide 10
Chapter 17 Slide 10 Implications of Asymmetric Information ◼ Automobile Insurance ⚫ Questions ◆ What impact does asymmetric information and adverse selection have on insurance rates and the delivery of automobile accident insurance? ◆ How can the government reduce the impact of adverse selection in the insurance industry? The Market for Insurance