Information Asymmetry And The Market For Lemons


Oscar Smee

Economics is a powerful social science that deals with the fundamental dilemma we face in all human societies: human desires are bounded by what we can produce and how we organise ourselves in light of these constraints. The field studies quite possibly the most complicated phenomena of any science. Every economic choice – what we desire, what we can produce – is influenced by a huge range of factors from diverse fields like biology, psychology, engineering and so on.

Like any science, the complexity of the phenomena studied by economics mean that simplifications and generalisations of human behaviour must be considered in light of  falsifiable models and theory.

Consider the mainstream neoclassical framework, which makes the following assumptions about human behaviour:

  1. Rational preferences: Individuals have well-ordered and well-behaved preferences amongst the set of possibilities available to them.
  2. Utility maximising individuals and profit maximising firms: Individuals will choose the highest utility bundle available and firms will choose production that maximises their profit.
  3. Full information for individuals and firms: Agents in the economy are aware of all prices, quality, etc. in the economy.

This basic framework is surprisingly powerful as a tool for building economic theory. From these assumptions we can build the neoclassical theory of the firm, demand and supply curves. Making the additional assumption of a large number of firms and preferences with the property of local non-satiation (there is no point such that an increase in consumption would make the consumer worse off) we can obtain the first fundamental welfare theorem, which implies that free markets tend towards pareto efficient equilibria. This means that the allocation of resources achieved by a free market cannot be changed to make any individual better off without making someone else worse off i.e. there is no ‘waste’.

The simple neoclassical framework can be very powerful as a basic framework for explaining economic phenomena and is applicable in a variety of real-life economic problems. However, all too often, economic laypeople (and even some people trained in economics) retain only the conclusions of the framework, disregarding the fact that these conclusions were predicated on assumptions that do not hold in all cases.

In doing this they miss a lot of the ‘richness’ of economic theory, which occurs when we relax the basic assumptions of human behaviour. In fact, one of the most interesting areas of economic research is information economics, which does away with the assumption of perfect information for buyer and seller and instead uses asymmetric information, where a party in a transaction has better or more information than the other. One of the most famous papers in the field of information economics is the 1970 paper “The Market for ‘Lemons’: Quality Uncertainty and the Market Mechanism” by George Akerlof, who later went on to win the Nobel Prize in Economics alongside Joseph Stiglitz and Michael Spence (also for their work in information economics). The paper is famous for its use of the used car market (although other markets are analysed) as an example of a market where there exists an information asymmetry with respect to the quality of the vehicle.

Akerlof supposes there is a used car market that has some cars that of high quality and some cars of low quality (lemons). Buyers cannot tell whether the car they are purchasing is a lemon or high quality, but they do know, or can estimate, the average quality of cars on the market. Sellers who have had time to drive and become very familiar with the car are able to better judge the quality of the car.  We therefore have an information asymmetry where one side of the market has a better assessment of the quality of goods.

Naturally, buyers will pay a higher amount for a high-quality car and sellers will seek a higher price for said high-quality car. But since buyers cannot tell the difference between good and bad cars, we can deduce that they must sell at the same price. High-quality sellers might raise their prices to reflect the higher quality of their cars, but remembering the fact that the buyer is unable to assess quality, the sellers of lemons can simply raise their prices to a matching level. This fact changes buyer behaviour. For a randomly selected car, buyers will not be willing to pay the price they would be willing to pay for a car they know is high-quality, on the chance that the car is a lemon. They will instead adjust their willingness to pay to be based on the average quality of a given car – more lemons in the market will lower the willingness to pay as there is now a higher chance of any given car being a lemon. That is, their willingness to pay will be in-between what the buyers would pay for a high-quality car and that which buyers would pay for a lemon, based on their estimate of the proportion of high-quality cars to lemons.

This is good for sellers of lemons. They can now obtain a price higher than that which they would be able to obtain if buyers had perfect information. For the sellers of high-quality cars, however, the price declines below that which they could obtain in a perfect information market. Naturally this will encourage some of the sellers of high-quality cars to exit the market, shrinking the proportion of high-quality cars on sale. Over time this leads to an even lower price (and even less high-quality sellers) as buyer adjust their willingness to pay downwards as high-quality cars leave the market and they are more likely to end up with a lemon. This feedback loop eventually leads to no high-quality cars being sold. Our market is no longer efficient because we could make a pareto improvement (i.e make someone better off without making anyone worse off). This pareto improvement is possible if we encourage high-quality car sellers to trade with buyers at the perfect information price. This failure of information symmetry is known as the adverse selection problem.

Obviously, the used car example Akerlof gives in The Market for Lemons is not realistic.  We know that cars are not of binary quality. But just like the basic neoclassical framework, it is a useful simplification which we can build upon to analyse a broader set of problems. In fact, adverse selection has a powerful effect when building insurance markets where the buyer of insurance has better information about their health than the seller.

In such a market, just as in the market for cars, the insurer must charge the same price to all buyers (as they lack the information to differentiate buyers) and this price must be based on an estimate of the average risk of the insurance being used. However, if the insurer sets the cost of insurance at the price based on the average risk, the insurance policy will only be purchased by people who know they will have a better than average risk and will be forgone by people with lower than average risk. This in turn drives the cost of providing insurance up for the insurer, relative to the cost of providing the insurance based on the average risk. The insurer is now only covering a self-selecting group of people with the highest health risks. This rise in cost will either raise the price of taking out insurance or force insurers to leave the market. In either case this is a market failure – individuals willing to pay for insurance and insurers willing to provide it cannot trade due to information asymmetry.

What can be done?

Government intervention can restore trade and create efficiency, solving the problem of adverse selection. For example, in insurance markets, mandatory insurance programs can bring about efficient outcomes by ensuring those who take out insurance are not simply high-risk individuals. In the used car market ‘lemon laws’ can solve the information problem, allowing buyers to return defective vehicles if they discover their car is a dud.

Solutions need not be solely governmental. In the case of insurance, free voluntary screening to estimate the need for insurance is a possible solution for some markets where low cost and accurate screening is available. It works by offering lower prices to those who are screened. A price based on the average risk of the unscreened population is set for the rest. This gives the lowest risk portion of the population the incentive to reveal their information and undercut the remaining portion to obtain a lower price. This remaining portion will now face a higher price due to the low risk portion leaving the group, giving the lowest risk portion of the new group the incentive to reveal their own information. Eventually, through this cascading effect, all portions of the population reveal their information. If this screening is low cost and accurate, the insurance market may be able to function efficiently. In the used car market warranties and brands allow high quality sellers to guarantee quality to the buyers, which can help counter the effects of information asymmetry.

The commonly held, dogmatic adherence to the idea that free markets are always and everywhere efficient forgets the assumptions we made to get to that conclusion and is not helpful in building the predictive and modelling power of economics. The valuable insights obtained from information and behavioural economics (which modifies the assumption of rationality) and other economics sub fields demonstrate the utility of questioning these assumptions. We should move to further integrate them into both mainstream economic theory and the public economic conscience, alongside our standard neoclassical model conclusions. Doing so will significantly increase the predictive and modelling power of economics, which will further allow us to improve our decision making and better allow us to deal with the big problems of the field.

Further Reading/Mathematical Treatment:

Click to access MIT14_03F16_lec22.pdf

Feminism in the Corporate Age

Economics, Philosophy, Politics

Tori Holliday

In 2006 The Economist proclaimed, “Forget China, India and the Internet, economic growth is driven by women.” Presenting a trifling new ideology to its readers, editors of The Economist echoed sentiments of a fresh feminist ideology, one which positioned women as the ultimate arbiter of neo-liberal society in its capitalist form – ‘womenomics’ – an untapped resource that identifies women as both conscious consumers and equitable distributors. The supposed “healthy dose of estrogen” required to heal the global political economy post-financial crisis provoked a new wave of feminist literature, one which attempts to interrogate the hegemony of neoliberalism.

Neoliberalism and feminism have become intertwined in a complex relationship of reciprocity, co-optation; exploitation and servitude, a mutual exchange of normative values in order to arrive at a shared platform of power. A platform which places gender equality as a foundation of accumulation and mechanization. Such a platform finds itself premised in contradiction. Neoliberalism requires the subordination of that with which it is partnered – its ideological foundations of self-interested extraction of available surplus, of the amoral utilization for, require nothing less. And so, why does feminism, as the path to emancipation, to freedom, to any normative something wherein the existential condition of women is bettered in the world, find itself so readily partnered with such an ideology? To paraphrase Wendy Brown: “ostensibly emancipatory or democratic political projects problematically mirror the mechanisms and configurations of power they purport to oppose.” Thus, feminism is not merely haunted by the spectre of neoliberalism: in its modern conceptions, it tacitly invokes the very values it seeks to deconstruct, becoming warped, shaped and defined by the ideology from which it is, by opposition, begotten.

In order to interrogate feminism’s shift into a neoliberal political space, it is necessary to consult the literature which provides potential explanations for such a phenomenon. Wendy Brown, formulating her intellectual prowess from Nietzsche, Marx, Weber and Foucault, presents an argument which attempts to address a myriad of problems that have grown out of the post-structuralist, postmodern, anti-foundationalist discourse of feminism. Brown’s States of Injury (1995) examines those who have become paralyzed by the postmodern feminist critique of the “subject” which decenters conceptions of “identity”, by positing that feminist scholars are infatuated with a subject which remains inherently masculine and liberal. Utilising aspects of the Nietzschean narrative, Brown suggests that a large proportion of American feminist academia is centered around “[an] epistemological spirit and political structure of ressentiment…” which constitutes much of the anxieties associated with an analysis that can balance the skepticism of postfoundational truth. She argues that feminists should transcend moral high grounds, if they intend to engage with a feminist politics which disrupts the possibility of ressentiment. In this sense, Brown advances an argument that attempts to solve the root causes of contemporary feminist theory’s “problems”: how does feminism avoid slipping into an epistemological space stripped of stability and rationality and replaced with a paralyzing, groundless feminist in-activism? More importantly, how can we, as social movement, aim to improve the lives of women both locally and globally, yet continue to pursue an emancipatory course of action which imitates the contexts they seek to interrogate? How can we critique – let alone reformulate – these conditions with a feminist political theory which lacks normative direction and value sets? Reflecting upon this argument by Wendy Brown in States of Injury, I will now attempt to analyse and critique Elisabeth Prügl’s recent work concerning neoliberal feminism.

As mentioned previously, over the last decade, a spate of articles has deliberated the concept of a ‘transnational business feminism’ or neoliberal feminism, a transition which has prompted much debate over its legitimacy. Feminists have become divided over whether this brand of feminism is a “genuine form of feminism” (Eisenstein 2017) or a case of co-optation at the hands of capitalism’s political figureheads. In her article, Elisabeth Prügl explores examples of TNCs, MNCs, NGOs and IFIs utilising feminist projects of empowerment, and coins this process as the neoliberalisation of feminism. Prior to her analysis of the neoliberal rationalisation of feminism, Prügl criticises feminist scholars for being highly invested within a narrative of co-optation, and instead encourages them to interpret these transnational and public development initiatives as a way forward for feminism. She interrogates what is lost and gained in the incorporation of gender in the global political economy, and implies that feminist intellects hold a naïve viewpoint dominated by a sense of theoretical nostalgia:

“…critics differ in what they do not like about this transformed feminism, but for all it is somewhat suspect, far removed from the challenges of power that underlies the contentious politics of feminist movements” (Prügl 2014).

Here, Prügl refers to a particular form of feminism – a pure radical socialist feminism – that tends to pervade arguments generated by the critics of neoliberal feminism. The lost world these feminists are yearning for, Prügl argues, is far removed from the current globalised form of governance that operates with and incorporates NGOs, International Financial Institutions, the state, and the private sector.

Prügl certainly does not assert that feminism ever was a singular ideology or practice, rather it has become a shared project, based upon the plurality of methodological assumptions, principles, and premises, that at times, hold deep-seated differences. Therefore, how can we declare neoliberal feminism to be a reactionary movement or an actual feminist ideology? For Prügl, the critiques of neoliberal feminism may be somewhat forthright, but scholars are yet to arrive at a compelling conclusion that goes beyond recycled historical utopias. Wringing our hands over co-optation, she argues, is the real potential risk that threatens the derailment of the revolutionary worldwide women’s movement. By analysing transnational business feminism projects, we can begin to find places for potential improvements for both the individual and women’s collectives. Indeed, Prügl presents a sensible proposition, one that echoes sentiments of a form of neopragmatism, inspired by Richard Rorty and many contemporary feminist scholars, namely, Iris Marion Young and Nancy Fraser. Yet, without dismissing the positive impacts these neoliberal projects of empowerment have had for women and girls in recent years, it is difficult to conceive the motives of Unilever, Nike, Goldman Sachs, and other global businesses as being as sympathetic as they suggest.  It is therefore difficult to harmonise with Prügl that neoliberal feminism is a benevolent development, unless one was prepared to advocate for a type of quasi-feminism that attempts to exploit the voices of the marginalised for the purpose of bolstering an already pervasive form of globalised capitalism.

Moreover, Prügl seems to bypass a critical aspect of this neoliberal co-optation that she is so readily able to dismiss. Scholars may be nostalgic, but we must question why. This nostalgia is the precise example for the current state of the feminist condition – there is a lack of vision, a normative vision. The majority of feminists may be critical of the current mainstream, neoliberal feminism, and may be nostalgic for the history of the feminist movement, but they are unconscious, discontent with the lack of belonging or motivation that is supposed to exist. Here, co-optation becomes two-fold: feminists can acknowledge its co-optation by the neoliberal capitalist juggernaut, but they cannot explain why. Reflecting upon Wendy Brown’s analysis of the postmodern condition, the non-foundational epistemological political theory has failed to provide feminist scholars with the certainty they need to continue the advancement of the feminist agenda.

Undeniably, feminism has spread itself into the far cruxes of contemporary society, and undeniably women established those existences through the fight of legitimating a cause. However, the methods and aspirations that carried feminism into fruition and implemented those changes throughout history have not necessarily remained the same, nor will they stay withstanding in our future movements. We must ask ourselves whether these practices can continue to foment an intellectually rich vision, or whether they work against the very currents we insist on riding. Considering feminism’s deep historical connections to the Age of Enlightenment and liberalism, as well as the current relationship formulated on the basis of arguably, co-optation, perhaps feminism is inextricably linked to the political ideologies it seeks to dismantle. Combining feminism’s neoliberal repurposing in its already paralysed temporality, emancipatory objectives transcend their initial collectivised localities and become resources exclusive to the individual.

What does this mean for the existence of feminism in its current analytically impoverished state? We must first ask the question of what feminism is and what feminism does. From a generally reductive standpoint, regardless of school of inquiry, philosophical background, practice, methodology, theory, praxis, feminism possesses a characteristic goal. A goal based upon the idea of emancipation, freedom, empowerment, liberation, equality of opportunity, equality of outcome, to be free from the shackles of oppression. Whatever word or phrase speaks to the place in which one stands within this body, feminists hold this characteristic to be true. A goal, however, is inevitably unsustainable. A goal cannot remain concrete. A goal is fluid, and reality is fluid, and therefore, the goal that attempts to live within or confront this reality cannot continue to remain within the skin in which it was born. It must continue to shed many skins – an act which in turn is regressive and self-destructive to the objective which was created by and for the social movement (feminism).

Here I offer a self-help guide for feminism. Feminism must therefore separate itself from the idea of a normative vision. But must be careful not to do so in such a way that it destroys itself as an idea, movement, theory, practice, and potential future. It must completely and wholly embrace its existence as a practice. It must reformulate its objectives into a set of negotiable, intangible, reflexive processes. As a social movement, feminism must acknowledge the importance and privilege these processes hold, so that it can continue to enact the movement it so readily desires to be. Without allowing itself to deconstruct the symbolic meaning of that ‘goal’ or even the attitudes and practices which proceed attempts to achieve that ‘goal’, feminism wades in the water. It stagnates in such a way that it becomes co-opted. Ironically, it could be said that there are no waves in the current for feminism to ride. Or that at any given moment, the possibility of apprehending the ramifications of not possessing an agenda or goal submerges feminism into murky waters.  And from within, feminists begin to watch it build, and become a crashing tidal wave, a tsunami of its own inevitable defeat.

Perhaps feminism should embrace the idea of a normative vision? If we consider the anti-foundationalist groundless political ground discussed by Wendy Brown, and the metaphysical skepticism implied within Prügl’s neopragmatic critique of neoliberal feminism, we arrive at a feeling the resembles one discussed in Vermeulan and Akker’s essay, Notes on Metamodernism (2010). They describe this current structure of feeling to be “characterised by the oscillation between a typically modern commitment and a markedly postmodern detachment” (Vermeulen and van den Akker 2010). Thus, looking within, between and beyond modern and postmodern conceptualisations, I encourage feminists to consider metamodern ideas of negotiation as the foundations of endeavour: a way of balancing political skepticism and relativism without becoming politically unbound and inactive. Feminists should see value creation and engagement with normative goals as the privilege that comes with emancipation. The decision to engage sincerely with goals, whilst acknowledging their construction, is what feminists ought to do. For the power of symbols – goals and values too – comes from the sincere engagement with them, not their inherent defensibility. In this way, feminists, and social movements more broadly, can continue to follow a vision that is repeatedly fading into the distance.

I propose that feminism should begin to reformulate itself as a political body by incorporating metamodern feelings and negotiations into its practices. In doing so, the integration of metamodern conceptualisations allows feminism to not only remain committed to the temporal orderings of liberalisms, and the spatial disordering that follows its postmodern characteristics, but it also allows feminism to pursue a destiny that remains within, yet unbounded by its past, present and future. I hope that this self-help guide can begin to close the old wounds of women’s studies, allowing feminism to affirm its errors in a moment silence, and then again, we can begin to cut deep and interrogate with a freshly hatched, normative emancipatory agenda.