The document discusses George A. Akerlof's theory of asymmetric information in used car markets, highlighting how differing knowledge between buyers and sellers leads to market failures and adverse selection. It illustrates that when buyers cannot differentiate between high-quality ('plum') and low-quality ('lemon') cars, they are inclined to pay a lower average price, which discourages sellers of high-quality cars from participating in the market. As a result, the phenomenon of 'lemons' can dominate the market, ultimately harming overall welfare.

1. Akerlof’s Lemon Vehicles Market
W.A Senathissa Sabaragamuwa University of Sri Lanka
George A. Akerlof

2. W.A Senathissa Sabaragamuwa University of Sri Lanka
George A. Akerlof
George A. Akerlof,
An economics professor at the University of California,
2001 - winner of the Nobel Prize in economic
Study on the role of asymmetric information in
the market for "lemon" used cars.
Established economic theory in illustrating how
markets malfunction when buyers and sellers as
seen in used car markets operate under different
information.

3. .Principle is related to the welfare economics.
W.A Senathissa Sabaragamuwa University of Sri Lanka
Market failures can be seen due to,
. Information failures (asymmetric information)
. Externalities

4. W.A Senathissa Sabaragamuwa University of Sri Lanka
.Information availability is a significance factor in
determining the welfare of the society.
.Imperfect information will caused to miss
allocation of the recourses.
.Asymmetric information: The buyer and seller
have unequal information about the vehicle's type.

5. .If there is perfect information available
in the society, the second- hand vehicle
market can not be existed.
.What does this model explain?
W.A Senathissa Sabaragamuwa University of Sri Lanka

6. . Buyers know only the distribution of quality.
. Assume Rational man is engaging with the
market deal
.Sellers know what kind of car they have,
but buyers can't tell.
Assumption
W.A Senathissa Sabaragamuwa University of Sri Lanka
Plum = Quality second-hand car
Lemon = Less quality second-hand car

7. .Owners of lemons are willing to sell for $1000
.Owners of plums are willing to sell for $2000.
Eg: Assume that,
.Purchasers are willing to pay up to $1200 for a lemon.
.Purchasers are willing to pay up to $2400 for a plum.
W.A Senathissa Sabaragamuwa University of Sri Lanka
A.P.
1500$
A.P.
1800$

8. .All buyers know is that half of all used cars are lemons.
.Therefore, based on the expected probability that a
given car is a lemon,
.they will pay only up to $1800 for any car
(1/2*1200 + 1/2*2400).
.But plum owners aren't willing to sell for only $1800
.Only the lemons will be sold, and the equilibrium
price will be between $1000 and $1200.
W.A Senathissa Sabaragamuwa University of Sri Lanka

9. .Adverse selection: The buyer risks buying a
car that is not of the type he expects--e.g. buying
a lemon when he thinks he is buying a plum.
W.A Senathissa Sabaragamuwa University of Sri Lanka

10. .To avoid this problems due to imperfect
information,
Under the services of the technicians certify the
worth of the vehicle trough the following
materials,
. The warranties/guarantees (shared risk),
. Iterated interaction (brand names, chains)
. Certification (credit reporting).
W.A Senathissa Sabaragamuwa University of Sri Lanka

11. .There is no any probability to exist the quality
car in 2nd hand vehicle market when Perfect
information is available in the economy.
Line is to be slow the anima
. when information is imperfect,
Inferior goods destroys the market for quality
goods (an externality problem).
Conclusion
W.A Senathissa Sabaragamuwa University of Sri Lanka