How To Make Better Decisions
The Lost Art Of Context
In 1970, economist George Akerlof published a paper called The Market for Lemons: Quality Uncertainty and the Market Mechanism, in which he described an idea that would keep researchers busy for decades: adverse selection.
The concept describes a type of market inefficiency. When buyers and sellers have different information about the goods or services being sold, whichever party knows more can dictate the outcome of the transaction.
For example, sellers of used cars know whether their vehicle is of good quality or breaks down every ten miles, (a so-called ‘lemon’) but potential buyers don’t. As a result, sellers overcharge. Akerlof dubbed this phenomenon ‘asymmetric information’ and predicted a market death spiral, in which, theoretically, no one would want to buy a car.
Of course the real used car market is very much alive, however inefficient. While measures to mitigate information asymmetry have been introduced, such as extended guarantees, inspections, and certifications, people still get ripped off every day.
But why? Akerlof received the Nobel prize in economics for his discovery and today, almost 50 years later, every US state has its own variant of the ‘Lemon law’ to protect consumers. Yet, we still make bad decisions, not just in purchasing…
