Question

the exhaust system on your 1985 car needs to be replaced and you suspect that the price of a new exhaust system is the same as what you would get if you tried to sell the car. if you know that the car is otherwise okay, what relevance does akerlof's model of lemons have to your decision about whether to purchase a new exhaust system?

Answer 1

The Akerlof's model of lemons suggests that asymmetry in information can result in market failure and adverse selection. This asymmetry arises because one party involved in the transaction has more information than the other and the same might be used to provide undue advantage to them. In case of lemons, the market failure results in only lemons(used cars) being sold in the market.

Now we have an exhaust system on a 1985 car and the same is needed to be replaced. We suspect that if we do the replacement, the new exhaust system might be a defective one because its price is same as what we would get if we tried to sell the car. if we know that the car is otherwise okay, we have to look at some other aspects, such as if the new system is verified or certified in order to have a signal about the quality. In this sense, the model of lemons helps us in keeping us vigil and wise in making selections and responding to signals to remove information asymmetry.