This section introduces three economists that began to study the economics of information. The first, George Akerlop, became interested in growth theory while studying at MIT. He studied the relationship between “fixed and variable capital-labor ratios” called a “putty-clay” model but soon moved on to study the market and price volatility in car sales.
Akerlop discovered that consumers are drawn to new cars because used cars may have hidden defects known only to the salesmen. In his own words, “If he wants to sell it, it’s probably because it’s a lemon, and I don’t want to buy it.” He soon published “The Market for ‘Lemons,’” where he describes the problems with adverse selection in different markets.
Another economist, Michael Spence, further addressed adverse selection in an article called “Market Signaling” explaining how two parties could overcome the problem of asymmetrical information through education and advanced degrees. This had a significant effect on markets that have problems with accessing quality like finance and insurance.
Joseph Stiglitz expanded this research and came up with screening mechanisms whereby one party could obtain information from another in order to solve the problem of adverse selection. A good example of this is insurance companies sorting customers into risk classes by means of varying deductibles.
C for Mitch - got to spell people's names correctly. Also, you mean "assessing" not "accessing".
ReplyDeleteBTW: Akerlof, Spence and Stiglitz were jointly awarded a Nobel Prize for this work about 10 years ago.
Akerlof's point is deeper than this: if we think all used cars offered for sale are lemons, the used car people won't bother to sell any decent used cars they get because no one will pay a fair price for them, and all that will be available for sale is lemons. It becomes a self-fulfilling prophecy.
Because macroeconomics has gotten intimately tied up with expectations (because policy-makers are trying to influence the future), self-fulfilling prophecies are a common feature of macroeconomics.
In some sense, the response to Obamacare has been that way. It includes coercive measures to ensure compliance with the new plan. But, people don't like being coerced, so they respond by being uncooperative. Which makes the coercion necessary to get the plan to work.
We've also seen this in international policy with Libya the past few weeks. Qaddafi looked like he was leaving because outside force was going to be used. When force wasn't used, he stayed and attacked his own people. Eventually, that led to outside force having to be used. Because force was going to be used it had to be used.