Subject: Newsletter
From: [email-masked]
To: [email-masked]
Cc: [email-masked]
Date: Sun, 21 Oct 2001 15:16:21 -0700 (PDT)

TheMarket for Lemons and the Price of Dishonesty 
The Nobel Memorial Prize in Economics was awarded thisyear to three economists: George Akerlof, Joseph Stiglitz and Michael Spence,who made significant contributions to modeling markets with information asymmetry.In many cases in a given market sellers or buyers may have exclusiveinformation that is not available to the counter party. The best-known examplecomes from the [paper by Akerlof, The Market for "Lemons": QualityUncertainty and the Market Mechanism, Quarterly Journal of Economics, 84,(1970), pages 488-500.  
An owner of a used car can form a good idea of the qualityof his vehicle. He has much better information if his car is a lemon. As bothgood and bad used car have to sell at the same price - it is impossible for anaverage buyer to distinguish between good and bad merchandise - they sellers ofgood used cars are driven out of the market. Most traded used cars will belemons. Of course, there are ways to mitigate the problem: an owner of a goodused car may send signal to the buyer by offering him a guarantee or absorbingthe cost of inspection. 
Hiring is a similardecision. As Michael Spence wrote in his paper Job Market Signaling,Quarterly Journal of Economics, 87, (1973), pages 355 - 374, to hire somebodyis frequently to purchase a lottery ticket. The employer cannot directlyobserve the productivity of a potential hire. "What he does observe is aplethora of personal data in the form of observable characteristics andattributes of the individual, and it is these that must ultimately determinehis assessment of the lottery he is buying." The observable characteristics of an individual may be immutable (raceand, generally, sex) but in some cases certain attributes are alterable. A candidatecan modify such characteristics as education and job history. Some economistssay, tongue-in-cheek, that some candidates who attended top schools and spentmany painful hours studying useless subjects signal their willingness to dowhatever it takes to succeed. Another way to send a signal about one's qualityis to find a job with a top firm at the beginning of one's career and tosucceed in this firm before moving on. This provides a useful lesson to anybodywho plans to be in the labor market at some points in his or her life: thereputation of the current employer is critical to future employmentopportunities and should be defended at any cost. Honesty, at the end of theday, is an imperative dictated as much by morality as by one's self interest.  

 - The Market for Lemons and the Price of Dishonesty.doc 
 - The Market for Lemons and the Price of Dishonesty.doc