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“lemons” and other examples of imperfect information

Consider Marvin, who is trying to decide whether to buy a used car. Let’s assume that Marvin is truly clueless about what happens inside a car’s engine. He is willing to do some background research, like reading Consumer Reports or checking websites that offer information about makes and models of used cars and what they should cost. He might pay a mechanic to inspect the car. Even after devoting some money and time collecting information, however, Marvin still cannot be absolutely sure that he is buying a high-quality used car. He knows that he might buy the car, drive it home, and use it for a few weeks before discovering that car is a “lemon,” which is slang for a defective product (especially a car).

Imagine that Marvin shops for a used car and finds two that look very similar in terms of mileage, exterior appearances, and age. One car costs $4,000, while the other car costs $4,600. Which car should Marvin buy?

If Marvin was choosing in a world of perfect information, the answer would be simple: he should buy the cheaper car. But Marvin is operating in a world of imperfect information, where the sellers likely know more about the car’s problems than he does, and have an incentive to hide the information. After all, the more problems that are disclosed, the lower the car’s selling price.

What should Marvin do? First, he needs to understand that even with imperfect information, prices still reflect information. Typically, used cars are more expensive on some dealer lots because the dealers have a trustworthy reputation to uphold. Those dealers try to fix problems that may not be obvious to their customers, in order to create good word of mouth about their vehicles’ long term reliability. The short term benefits of selling their customers a “lemon” could cause a quick collapse in the dealer’s reputation and a loss of long term profits. On other lots that are less well-established, one can find cheaper used cars, but the buyer takes on more risk when a dealer’s reputation has little at stake. The cheapest cars of all often appear on Craigslist, where the individual seller has no reputation to defend. In sum, cheaper prices do carry more risk, so Marvin should balance his appetite for risk versus the potential headaches of many more unanticipated trips to the repair shop.

Similar problems with imperfect information arise in labor and financial capital markets. Consider Greta, who is applying for a job. Her potential employer, like the used car buyer, is concerned about ending up with a “lemon”—in this case a poor quality employee. The employer will collect information about Greta’s academic and work history. In the end, however, a degree of uncertainty will inevitably remain regarding Greta’s abilities, which are hard to demonstrate without actually observing her on the job. How can a potential employer screen for certain attributes, such as motivation, timeliness, ability to get along with others, and so on? Employers often look to trade schools and colleges to pre-screen candidates. Employers may not even interview a candidate unless he has a degree and, sometimes, a degree from a particular school. Employers may also view awards, a high grade point average, and other accolades as a signal of hard work, perseverance, and ability. Employers may also seek references for insights into key attributes such as energy level, work ethic, and so on.

Questions & Answers

how environment affect demand and supply of commodity ?
Amos Reply
Wht at the criteria for market ?
Amos
what is difference between monitory policy and fiscal policy?
Malik Reply
monetary policy is a policy thrust by National Govt(CBN) to influence government spending, purchase &taxes
Frank
necessity of economics
Pamela Reply
I will say want,choice,opportunity cost,scarcity,scale of preference
Alao
what is monopoly market.How price output are determined under monopoly market
bisham
b) Monopoly market is an impecfect market where s single firm having the innovation to produce a particular commodity.Prices are determined through output since there are no other competitive.
Frank
Monopoly market:firm has market power & does not respond to market price
Frank
Explain the process of price determination under perfect competition market with suitable diagram
bisham Reply
Price determination under perfect competition via this process :firms have no market power to influence price rather firms respond to market price.
Frank
price is different from demand- demand is amount of commodity
Effah Reply
demand is amount /quantity of commodity a potential buyer is willing to buy at a given price at market
Frank
demand is a desire of customer on commodity with the ability to pay it and willing to buy it at given price of commodity
Harika
demand is price of what
Faith Reply
show that shortrun average cost
Baby Reply
what is economics
Mbah Reply
what is money
Mbah
what is money
Mbah
Difine macro economics
agaba
money is a medium of exchange between goods and services,maybe inform of currency.
Wesonga
Economics is study of how human beings strive to satisfy numerous wants using limited available resources.
Wesonga
how do you find the maximum number of workers the firms should employ order to produce where there are increasing returns
Jane
what are implications of computing national income?.
agaba
pl
MUDASIRU
what is the formulae for calculating national income
MUDASIRU
it calculated by value added method
Praveen
classify the production units like agriculture, banking, transport etc
Praveen
money is anything that is generally acceptetable for human
Ogbaji
Estimate the net value added(NVA) at fixed cost by each industrial structure
Praveen
definition of unemployment
Adam Reply
what are the causes of unemployment?
Mbubi Reply
The main causes of unemployment are listed below. 1. Frictional unemployment 2. Cyclical unemployment 3. Structural unemployment
assani
We can also categorize the causes on a broader sense as: 1. Political and 2. Social cause As unemployeement root causes are embaded in this two.
Yonathan
would opportunity cost exist if there was no scarcity?
assani
yes just because the opportunity cost arose when there is Alternative to choose among the alternatives.
BADAMASIU
I am thinking that, if our resources were unlimited, then there wouldn't be any need to forgo some wants. Hence the inexistence if opportunity cost
assani
Politics
Job
politics has done what?
assani
consider time assani
Mary
I'm Emmanuel,...I taught the main cause is the change in gov't.
Emmanuel
...Lack of capital to set up a firm respectively
Emmanuel
🙈
Emmanuel
I would like to bring in Educational levels can also be the cause the cause of the problem respectively
Emmanuel
I think the main causes of unemployment is lack of INFRASTRUCTURAL DEVELOPMENT OVER POPULATION OVER DEPENDENT ON GOVERNMENT LACK OF SELF EMPOWERMENT...
ananti
lack of skills among the new generation is the serious issue.
Vishal
Where I come from , I don't see why education or personal aspects seem to do with unimployment, technically the motivation and eigerness in all works of live is there , dispite the cultural influence and physical bearriors;the thing we lacking is Government Support and open market ethics.
Joe
sorry about that-(repation). We have a over powering ethical political system that's displacing the marketing asspects of economy and causing large scale unemployment right across the board...
Joe
can someone Explain Expansionary Monetary Policy and Contractionary Monetary Policy Using one of the instrument of Monetary Policy? Please am kinda lost here?. ta
Emmanuel Reply
using a graph show the case of substitute and compliment goods
Ade Reply
can anyone give me a simple explanation to Five Sector Macroeconomics?
Emmanuel
Can someone please define what economics is
jason Reply
economics simply is a social science subject that study human behavior.
dajan
economics is a social science which studies human behaviour as a relationship between ends and scarce means that has alternative uses
Alao
Can someone please tell me how to calculate GDP
Emmanuel
emmanual kapal to calculate GDP (Gross Domestic Product) has three method in calculating it (1)income approach (2) expenditure approach (3) value added method
Alao
thanks Alae
Emmanuel
u are welcome
Alao
in basic terms economics is revered to as battery system, it date back to when Men sees the need to exchange sapless goods and produce to gain , either wealth , basic necessities or to establish trading ties for personal benefit or social asspects in terms of coexistence and continuity, future .
Joe
what is the law of demand
Berlinda Reply
keep other thing constant, when the price increases demand decrease when the price decreases demand increases of the commodity.
sj
all things being equal,quantity demanded decrease as price increase and increase as price decrease
Seth
there's practial joke to it ..." the higher the demand ; scarcity, increase in production and drop in quality"... quite the controversy - for example China vs Europe, United States and we are all boxed up in between somewhere...
Joe
Other thing remain constant the low price of commodity the high quantity of commodity and vice versa is true
Baraka
Explain Effective demand
Anita Reply
What is effective demand
Anita
like Modi is in demand...best example of effective demand
Pranav
Don't get you
Anita
Anita you mean you don't get me or who?
Onyeking
level of demand that represents a real intention to purchase by people with the means to pay
Pranav

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Source:  OpenStax, Principles of economics. OpenStax CNX. Sep 19, 2014 Download for free at http://legacy.cnx.org/content/col11613/1.11
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