Page 52 - Zenith2024

Zenith 2024

Blockchain technology as an

antidote to lemon economics

Lemons: they look tasty on the outside, but surprisingly sour
on the inside. The term lemon markets was used throughout
the economic spectrum starting from the 1970s, when George
Akerlof coined the term after he discovered that the unpleasant
surprise of lemons was reminiscent of poor cars circulated in
the used car market. To him, the market for used cars would always involve a sense of information
asymmetry, ultimately leading to a market failure.

Lemon markets are divided into two main categories depending on what group has the upper hand
at information collection. The most common form of lemon markets is when the seller has more
information. This means the buyer is in a state of panic; he knows not the
best choice to make, and thus tries to strike a negotiation between the
range of choices. Take the used car market as an example. Say there is a
car worth 4000 dollars and a car worth 1000 dollars. The buyer doesn’t
know which car is which so he isn’t sure about paying 4000 dollars. Thus,
he strikes a balance between the two price points, only willing to pay
around 2500 dollars for a used car. The seller here obviously doesn’t want
to sell his car worth 4000 dollars, so he bails out of the market. The cars
worth 4000 dollars are no longer left in the market, further driving down
the average price of the used cars, thus bringing down the price that the
purchaser is willing to pay. This process repeats itself until the only cars left
are the cars worth 1000 dollars. The buyers most likely wouldn’t want to purchase these low-end
cars, eventually leading to no purchases and no sales. It’s a market failure.

On the flipside, if the purchaser, or in this case the customer has more information, a market failure
occurs in a different way. This mainly occurs in situations where services are provided for the
customer. Take insurance as a representative example. Insurance is provided towards customers,
but insurance companies don’t have the faintest idea as to who has more accidents, thus costing
the company more. Companies prefer to take in low-risk customers, but as they can’t distinguish
between the two, insurance companies tend to set premium prices for insurance. As the low-risk
individuals don’t need insurance services that often, they will be unwilling to pay that larger amount
of money. As a result, low risk individuals are left without insurance and insurance companies have
to provide services to only high-risk individuals, hurting the company and also indeed leading to a
market failure.

Nowadays, lemon markets have the biggest impact on the stock market and company bonds.
Investors may have trouble placing value on corporate stocks if information about the corporation is
not fully disclosed. More and more people are getting involved in investing in stocks and as the range
of people continues to increase, people without access to adequate information also increases.

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