George Akerlof’s The Market for Lemons describes market failure by information asymmetry, using the example of the car market. You can see the same idea at work in many other domains.
If I’m selling a car, I want a profit on it. If it’s a good car, it’s worth more, and I’ll ask a higher price. If it’s a defective car – what’s called a lemon – I’ll be happy even with a lower price. And if I’m buying a car, I don’t want to pay more than what it’s worth. If I’m paying high, I want a good car, though I might pay low if I’m OK with a lemon.
There’s information asymmetry at work, because the seller knows what kind of car he’s got, and the buyer doesn’t – all he knows is what the seller tells him. Obviously, as a buyer, I can make certain deductions. Imagine a new car costs 5 million, and a used one 2 million, and at the outset, no one knows how many of which kind constitute the market. Buyers might be tempted to offer an average price of 3.5 million, assuming 50/50 odds of getting a good car.
A seller of lemons would jump at that offer – he’s getting far more than his product is worth. And someone with the genuine article would definitely not sell at that price for a loss. So buyers only attract lemons, and realize they’re not getting good cars. If they now update the 50/50 odds to a more realistic 30/70, they offer 2.9 million, and still attract lemons. Eventually, the odds are 0/100 – lemons flood the market, and no good cars exist, and everyone knows that.
And so, bad products drive out good ones, where information asymmetry exists. A similar thing plays out elsewhere – someone with higher risk is likelier to buy health insurance, worsening the odds for firms. Or a company can’t know whether someone they’re hiring is smart or motivated or neither, and so asks applicants to jump through hoops – degrees, exams and the like – to improve the odds of guessing well. Online platforms do solve this problem to some extent through reviews, though there again, faking exists, as well as the ever-present question of how highly you regard the opinion of a random peer.
The market for lemons is a problem everywhere. Assume, as is not too unreasonable, that people aim for higher paying or prestigious jobs. A firm that pays poorly self-selects for less qualified candidates, people who probably couldn’t or wouldn’t make the cut elsewhere. One that pays well, though, is flooded by both types, those who meet their requirements and those who simply try their luck. Here, the applicant is akin to the car seller – only he knows the true quality of the product, which is himself. The firm, like the buyer, strategizes – it might have a thorough hiring process to minimize wrong judgments, or could pay middling wages, not too low, but not too high, in case of any error of judgment in its hiring. As it builds up confidence – such as recruiting year after year from a campus – it eventually forms a stable opinion. This is obviously a simplified example, ignoring market forces of demand and supply, and a rather crabbish tendency to pay the bare minimum you can get away with.
Information asymmetry is one thing, but misinformation is another. It’s the difference between not telling the truth, and actively lying, or at least, trying to lead someone along a particular path. What if the seller of the defective car tries to dress up his car as the real product, making it harder to assess its quality? It’s not a far-fetched idea either. In fact, in the battle between weak, flabby morals, and cold, hard profits, it’s the most likely outcome, mitigated only to a very minor degree by the law. Pretty much the same battle is waged everywhere. It could be the outlandish claims of ed-tech businesses promising to make you wealthy, or snacks and beverages claiming to make you healthy, or pseudo-intellectual influencers pretending to be wise. In each case, one purports to be exactly what one is not.
This applies all the more when it comes to people. If I meet someone I’ve been wanting to meet, for whatever reasons, personal or professional, I probably wouldn’t want them to think I’m a lemon, though I may well be one. And so I make every effort to signal my value, to give the impression that I’m the real deal, not a lemon. In this case, again, the information asymmetry lies in that only I know my reality, and the misinformation that, whatever my real nature, I take pains to portray a certain image, whether genuine or artificial.
The consequences of this little deception might be painful if I manage to pull it off. Imagine a kaput little car, that manages to behave well during a test drive and succeeds in tricking a prospective buyer into paying a high price for it. Now it faces the alternatives of keeping up the deception forever, or of revealing its true nature. If it could keep the deception alive forever, though, it probably wouldn’t have been a defective product in the first place, so that alternative is ruled out – although, even if it was possible, it would surely be painful to constantly masquerade as something you’re not for eternity, never taking off the mask even for a moment.
And when the mask slips, and the deception is revealed, what then? Then I imagine the awkwardness and pain of being unmasked, and the nearly inevitable fate of getting the axe. Moving from cars to people, we have the case of someone who flukes or deceives their way into a job they’re not qualified for, or performs and masquerades as someone they’re not to charm another.
So much for individual behaviour, but markets are about aggregate behaviour. The market for lemons is, after all, not about the game an individual buyer plays with a seller, but the cumulative outcome that all such games lead to.
What happens when many people try to portray being something they are not? I think that’s how you come up with arcane norms and codes of etiquette. It’s akin to how the idea of a lawn, a large mass of unproductive land into which you pour money and labour to grow grass for no good reason, came about. A way to signal that you’re wealthy – by being able to devote land and labour for something of no use.
Complex mannerisms, table etiquette, social codes, dressing styles share the same traits with lawns – you spend significant time and effort to learn something of no use to anybody whatsoever, that you or others think looks good. In other words, a signal, that you’re part of the club, or at least, that there’s a chance you might be. When enough people do it, it becomes the new floor, a necessary but not sufficient threshold you have to pass to even be considered, like a high SAT score. A low score will probably kill your application, but a high score isn’t nearly sufficient to get through.
It can become a race to the bottom, such as when everyone stays overtime for fear of looking bad, or everyone wears uncomfortable clothing because it’s the done thing, or everyone brown-noses. In short, you have a large number of people doing things none of them individually want to. These are, also, I think, vicious cycles, and hence stable equilibriums, because not participating, that is, not playing the game- dressing informally, or eating casually, or leaving early – is only likely to bring a penalty on the one who doesn’t play along. And so, looking at it from the cost-benefit point of view, it’s usually easier just to play along than to enact some kind of defiance. In some ways, this is like the prisoner’s dilemma, in that everyone is in a situation which is sub-optimal, in that there’s a scenario that’s better for everyone, but it’s practically impossible to get there.
It is still, ultimately, a choice, for every individual, albeit a harder one, that’s skewed heavily in one direction.