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Market for Lemons. A market full of “lemons” or unreliable products may result from differences in information on product quality between buyer and seller. Buyers may base demand for a good such as a used vehicle on the average quality of the good in the market.

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market for lemons
Market for Lemons
  • A market full of “lemons” or unreliable products may result from differences in information on product quality between buyer and seller.
  • Buyers may base demand for a good such as a used vehicle on the average quality of the good in the market.
  • May drive out of the market the supply of good vehicles – further decreasing the quality of vehicles on the market.
a direct test of the lemons model
A Direct Test of the “Lemons” Model
  • This paper directly tests the idea that used vehicles (trucks) differ in quality from the market for new vehicles.
  • Quality measured by the (lack of) maintenance on a vehicle.
  • Data for the study taken from a 1977 survey of truck owners that records:
      • the model year of truck
      • whether the truck belongs to original purchaser or was acquired used
      • truck’s mileage
      • whether the truck required major maintenance in the preceding 12 months
a direct test of the lemons model3
A Direct Test of the “Lemons” Model
  • Data indicates whether any maintenance was undertaken in any of five categories (engine, transmission, brakes, rear axle, and other).
  • Data doesn’t provide information on actual cost of maintenance.
  • The implication of the “lemons” model is that used trucks would on average be lower quality.
  • Need more maintenance than trucks purchased new.
a direct test of the lemons model4
A Direct Test of the “Lemons” Model
  • Paper initially presents evidence only for engine maintenance.
  • In three of the years, a higher proportion of used trucks required engine maintenance than new.
a direct test of the lemons model5
A Direct Test of the “Lemons” Model
  • Simple comparison of sample proportions is a crude test of “lemons” hypothesis.
  • Used trucks for every model had on average much more mileage than trucks owned by original purchasers.
  • Vehicles with more mileage would normally require more maintenance.
a direct test of the lemons model6
A Direct Test of the “Lemons” Model
  • Paper groups trucks by model year and mileage range.
  • Compares the proportion of each group requiring maintenance in each of the five maintenance categories.
  • Tests for statistical significance of difference in proportions.
a direct test of the lemons model7
A Direct Test of the “Lemons” Model
  • An example of a grouping:
      • 1974 model year trucks
      • With between 40,000 and 50,000 miles
  • Compares proportion of the new and used trucks that required a specific maintenance (engine, transmission, brakes, rear axle, and other).
  • Paper makes up to four comparisons for each grouping.
a direct test of the lemons model8
A Direct Test of the “Lemons” Model
  • Tests for statistical significance.
  • The difference in sample proportions must be large in order to conclude that a relationship holds generally for all trucks.
  • Hypothesis is that used trucks with fewer miles will more likely be relative “lemons” than those with more miles.
a direct test of the lemons model9
A Direct Test of the “Lemons” Model
  • Paper finds that in most cases, used trucks are not inferior to new.
  • Concludes little evidence of “lemons” in the market for trucks.
test of the lemons model comment
Test of the Lemons Model: Comment
  • This paper argues previous paper used incorrect methodology to test lemons model.
  • Using same data, paper finds evidence of lemons by making two changes in methodology:
    • Directly estimates maintenance costs
    • Groups trucks by distinguishing between relatively new owners and those who are not.
test of the lemons model comment11
Test of the Lemons Model: Comment
  • Paper converts maintenance data into dollar costs by using information on average costs by category (in 1977):
test of the lemons model comment12
Test of the Lemons Model: Comment
  • Separates trucks into:
    • Those that had been purchased (used) within one year of the 1977 survey.
    • Those that been acquired either used or new in previous period and kept by owner. No transaction had taken place within a year of the 1977 survey for those trucks.
  • Hypothesizes that recently transacted trucks in the used market are more likely to be lemons.
  • Owners who have held on to their vehicles are discouraged from selling because of the lemons problem.
test of the lemons model comment13
Test of the Lemons Model: Comment
  • Finds that trucks that have been transacted in a given time period have significantly higher average maintenance costs.
  • The difference in means is statistically significant and is evidence of a “lemons” problem in the market.