Asymmetric Information

{'type': u'plain'}

♪ [music] ♪

- [Narrator] The famous comedian
Groucho Marx once said,

- [Groucho] "I don't want
to belong to any club

that would accept me as a member."

- [Narrator] Believe it or not,
the economist George Akerlof

won a Nobel Prize for analyzing

when Groucho-type
reasoning makes sense

and what the consequences are.

Groucho was using the fact

that the club was offering
him membership

to infer something about
the quality of the club.

- "Yeah, because it's
not very exclusive."

- Akerlof analyzed
the more general situation

of adverse selection

when an offer conveys
negative information

about what is being offered.

Akerlof's famous example
was the market for used cars.

Suppose that used cars
come in a variety of qualities.

From the worst -- the lemons,

the cars that always
are breaking down,

to the very best,
the most reliable cars -- the plums.

The sellers know
the quality of their car,

but suppose
that the buyers can't tell

which used cars are lemons
and which are plums.

Since the sellers have
more information than the buyers,

this is a model
of asymmetric information.

Since the buyers
can't tell the difference

between a lemon and a plum,

they won't be willing to pay more

than what an average
quality car is worth.

But seeing that the buyers
are only willing to pay

for average quality,

sellers of the highest quality cars --

the plums --

will exit the market.

When the highest quality cars
exit the market, however,

the average quality of car falls,

which reduces the price the buyers
are willing to pay even more.

And that causes the sellers

of the next
highest quality used cars

to drop out of the market as well.

At the end of what is sometimes
is called "the death spiral,"

the market collapses
and buyers conclude,

just like Groucho,

that they wouldn't want

to buy any car
that is offered for sale.

Of course, in the real world
the used car market is thriving.

Some 40 million used cars
are sold every year --

more than three times
the number of new cars.

That doesn't mean
the model is wrong.

It means that over time
the market has developed solutions

to the asymmetric
information problem.

Solutions like inspections,
CARFAX reports,

and certified pre-owned programs

that offer buyers
guarantees of quality.

The Adverse Selection model
also has implications

far beyond the used car market,

most importantly
to understanding debates

over health insurance,

as we discuss in future videos.

- [Narrator] If you want
to test yourself,

click "Practice Questions."

Or if you're ready to move on,
just click "Next Video."

♪ [music] ♪