Our group’s presentation on Wednesday for Econ 206.

Notes Click Here   Paper Click Here

Background:

Akerlof explains his motivation for writing “The Market for Lemons” by arguing that microeconomic theory models in the 1960s were characterized by their generic nature{they dealt with perfect competition and general equilibrium. Situational and speci c considerations were left out (such as information asymmetries). By the 1990s more speci c theory models be came important. Now, economic models are custom, describing important features of observed situations. Since “lemons” exempli ed this new style, it was an integral part in the transformation of how theory was presented and discussed.

Akerlof notes that investigations of the car market were driven by his interest in macroeconmic issues such as the business cycle and unemployment. He wanted to know what caused the business cycle{noting that at the time this was related to the signi cant variation in new automobile sales. He wondered why this uctuation existed for new cars, and attempted to understand why people bought new cars, rather than renting or buying used ones. Akerlof noticed that the presence of information asymmetries served as an explanation as to why people preferred to purchase new cars rather than used cars” noting “their suspicion of the motives of the sellers of used cars.”

Extensions of this paper can be made to virtually any situation in which asymmetric information exists. This can happen in any market where the true quality of goods is dicult to perceive. This paper uses the auto mobile market as an explanatory example. But the explanatory capacity of the Lemon Principle are enormous.

Ironically, this theory was rejected on multiple accounts. According to Akerlof himself: “By June of 1967 the paper was ready and I sent it to the American Economic Review for publication…Fairly shortly…I received my first rejection letter from the American Economic Review. The editor explained that the Review did not publish papers on subjects of such triviality….Michael Farrell, an editor of the Review of Economic Studies, … had urged me to submit Lemons to the Review, but he had also been quite explicit in giving no guarantees. I submitted Lemons there, which was again rejected on the grounds that the Review did not publish papers on topics of such triviality. The next rejection was more interesting. I sent Lemons to the Journal of Political Economy, which sent me two referee reports, carefully argued as to why I was incorrect. After all, eggs of di fferent grades were sorted and sold (I do not believe that this is just my memory confusing it with my original perception of the egg-grader model), as were other agricultural commodities. If this paper was correct, then no goods could be traded (an exaggeration of the claims of the paper). Besides – and this was the killer – if this paper was correct, economics would be di fferent.”