Thursday, November 19, 2015

Would you buy a secondhand ship from him?

Never buy from a shop which doesn’t put its prices on the window. Never buy on the internet from a vendor who asks you to contact him for a quotation. Why is that? The answer is to be found in the theory of asymmetric information, for which George Akerlof, Michael Spence and Joseph Stiglitz won the 1971 Nobel Prize in economics. In simple words, the seller knows more than you do about the product he is trying to sell you, and he is counting on his good salesmanship skills to sell it to you at a price above the one you would be prepared to pay, were you to know the things that he does. The English have an expression for an untrustworthy person: “would you buy a secondhand car from him?”, they ask. The pioneering work on the theory of asymmetric information is Akerlof’s 1970 paper “The Market for Lemons: Quality Uncertainty and the Market Mechanism”, Quarterly Journal of Economics 84: 353–374. Although the example Akerlof used was also from the secondhand car market (“lemon” is American slang for a bad car), the theory has found important applications in finance; medical insurance; crime prevention; industrial concentration; and much more. In the latter field, Akerlof and his coauthor, Janet Yellen, have also carried out groundbreaking work on pricing in concentrated industries. Incidentally, Yellen, the current chairperson of the Federal Reserve System, is Akerlof’s wife. Apparently, George knew something others didn’t, for Janet proved not to be a lemon after all… HH

PS: Two related expressions, also English, are cases in point. The first comes from banking: “bad money drives good money out”. The second is often quoted in third party liability insurance markets in shipping (P&I Clubs): “I don’t want to be member in a club which wants me as a member”.