Relay-Version: version B 2.10 5/3/83; site utzoo.UUCP
Posting-Version: version B 2.10.2 9/18/84; site gargoyle.UUCP
Path: utzoo!linus!philabs!prls!amdimage!amdcad!decwrl!decvax!bellcore!petrus!sabre!zeta!epsilon!gamma!ulysses!mhuxr!mhuxn!ihnp4!gargoyle!carnes
From: carnes@gargoyle.UUCP (Richard Carnes)
Newsgroups: net.politics.theory
Subject: Re: The free market
Message-ID: <225@gargoyle.UUCP>
Date: Wed, 23-Oct-85 18:51:55 EST
Article-I.D.: gargoyle.225
Posted: Wed Oct 23 18:51:55 1985
Date-Received: Thu, 31-Oct-85 03:59:22 EST
Reply-To: carnes@gargoyle.UUCP (Richard Carnes)
Distribution: net
Organization: U. of Chicago, Computer Science Dept.
Lines: 70

[carnes]
>>Let us say there is a town with owners of used cars and potential
>>buyers of the cars. ...  A potential buyer
>>must assume that a used car he is looking at is of average quality...

[JoSH]
>This is a fallacy, and if the original paper is based on it, it's 
>completely spurious.  Considering that the conclusion, that no one
>will buy or sell used cars, is completely at odds with reality,
>that doesn't seem unlikely.  
>
>Assigning the average (of whatever kind) to an unknown random variable
>is only valid in certain circumstances.  
>... if 
>you can show some things about the distribution of the variable,
>with constraints on what you can validly use the "value" for.
>
>Suppose the example were changed to be more true to the model:  instead
>of cars let's talk about sealed boxes with money in them.  (Note that
>the theory assumes a car has a fixed "value", which is absurd.)
>With a few minor modifications, the model reduces to gambling,
>in which people pay for an unknown quantity with a mathematically
>expected value below the fixed price.  If we were to believe the logic,
>gambling would not occur.  But people gamble routinely for expected
>payoffs of less than 50%!!!  

The "lemons" model is one of a class of models of interaction known
as critical-mass models.  The point of the model will be clearer if I
reproduce T. Schelling's remarks about it in *Micromotives and
Macrobehavior*.  [I recommend this book to readers of this newsgroup.
It's very readable as well as theoretically important.  The point of
*M&M* is to show that one cannot simply add up individual decisions
and assume the total to be a simple sum of the decisions; at some
threshold the aggregate consequences may negate the individual's
intentions.  What each individual wants can in the aggregate become a
situation that no one wants (as in the case of seatbelt non-use, a
point that is overlooked by libertarian critics of seatbelt laws).]

"[Akerlof] argued that the seller of a used car knows whether or not
it is a lemon; the buyer has to play the averages, knowing only that
some cars are lemons but not whether the particular car he's buying
is.  Buyers will pay only a price that reflects the average frequency
of lemons in the used-car crop.  That average is a high price for a
lemon but understates the worth of the better cars offered on the
market.  The owners of the better cars are reluctant to sell at a
price that makes allowance for the lemons that other people are
selling; so the better cars appear less frequently on the market and
the average frequency of lemons increases.  As customers learn this,
they make a greater allowance for lemons in the price they're willing
to pay.  The cars of average quality in the previous market are now
undervalued and their owners less willing to sell them.  The
percentage frequency of lemons continues to rise.  In the end, the
market may disappear, although institutional arrangements like
guarantees, or the certification of cars by dealers who exploit a
reputation for good cars, may keep the used-car market alive.  

"Akerlof generalized this model to a number of markets in which there
is unequal information on the two sides -- insurance companies know
less than you do, usually, about whether you are accident prone, or
susceptible to hereditary diseases, or are contemplating suicide.
Life insurance rates for sixty-five-year-olds must allow for a large
fraction who are not long for this world.  And those who know they
are healthy and have a family history of longevity and are exposed to
few risks have to pay the same premium as the poorer risks; life
insurance being unattractive at that price, few of them buy it.  The
average life expectancy of the customers goes down, the rates go up
further, and the bargain now looks poor even to those of normal life
expenctancy.  And so forth."  [T. Schelling]
-- 
Richard Carnes, ihnp4!gargoyle!carnes