Akerlof lemons and Hayek entrepreneurs

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The canonical example of Akerlofs lemons model is the used car market. Determining whether a car is a lemon (poor quality) or a cream puff (high quality) requires experiencing the good - driving for a period of time in order to ascertain defects in the vehicle. Owners of used cars have this experience and, therefore, have better knowledge of the car's quality than potential buyers. They know whether it has been properly maintained, whether it has been in an accident, whether the brakes are safe, or whether there are hidden defects that appear intermittently like electrical shorts or vibrations. It is certainly conceivable that defects such as these could be concealed from potential buyers who are able to inspect such a vehicle in person. It is, on the other hand, certain that they could be concealed from a potential purchaser shopping for cars online whose only information about a particular car's quality is gleaned from a seller's description as posted on the Internet.

From an Akerlof lemons perspective, the tendency would be for Internet markets to be inundated with malfeasants attempting to defraud potential purchasers outright by taking their money and neglecting to ship ordered goods, a potential problem more severe than misrepresented product quality. Given that goods are almost universally shipped only after the purchaser remits payment and that individuals can effortlessly remain anonymous while interacting on the Internet, it is an ideal environment for such miscreants to flourish. Offering to sell goods on eBay with no intention of shipping the expected good is easily achieved. After payment is remitted the miscreant neglects delivering the good(s), then subsequently changes his or her identity and begins anew, a rarely observed occurrence, even in online auction sites.

Akerlofs premise is correct in that an effective and efficient mechanism compelling cooperation being absent, human nature elicits opportunistic behavior in markets beset with asymmetric information. Sellers of poor quality goods can internalize the benefits of providing false or misleading information, imposing direct and indirect costs on others. What Akerlofs model tends to ignore, we contend, is the dynamism of markets and the incentive mechanism driving entrepreneurs to discover ways to ameliorate problems associated with market exchange. Akerlof (1984: 16) does address the role of the entrepreneur in abating problems with asymmetric information, stating "[T]hose who can identify used cars in our example and can guarantee the quality may profit by as much as the difference between type two traders' buying price and type one traders' selling price," a prescient reference to Carmax, a company founded 25 years after publication of this seminal piece. But, he denounces such entrepreneurial endeavor as a waste of resources; that in the neoclassical world of completely homogeneous goods there would be no variations in quality; hence the use of labor for anything other than production of these homogeneous goods is a wasted resource. Entrepreneurship, in other words, may work to minimize the problems of quality assurance in marketing, but in the process resources are diverted from production activities. Markets with product variation and the activities associated with assuring quality in such markets are impediments, rather than sources, of economic development in the Akerlof lemons model.

Honesty and truth telling possess public goods characteristics in that individuals need not expend resources verifying accuracy and completeness of transactions when market participants act with the interests of others in the community (Hollis 1998).6 Economic goods are produced and sold in various forms and qualities, and disagreements between exchange partners often emerge as a result of miscommunication or dissimilar characterizations regarding quality or quantity attributes of these goods or services, not of intentional deceit. Lack of knowledge by both seller and buyer is as common in transactions as asymmetric information. It is this knowledge deficiency on the parts of both buyer and seller that makes middlemen (who are generally lower cost producers of information than consumers) a vital resource in market exchanges.7 Indeed, once the diffusion of knowledge in society is recognized, the various roles that entrepreneurs take on within the economic system can be seen as providing wealth-maximizing services rather than as detractions from other productive activities.8

Real estate, for example, is a heterogeneous good and is the single greatest asset in terms of cost in which most people invest. Additionally, most people engage in real estate transactions infrequently, leaving them with little experience in buying and selling a home. Real estate transactors, therefore, must rely on the recommendations of a local real estate agent who, by law, maintains a fiduciary responsibility to the seller. In response, relocation services have emerged, establishing relationships with real estate agencies to provide broker services to both buyers and sellers in exchange for providing them with referrals.9 These relocation companies act as monitors in a principal-agent relationship, providing assurances to buyers and sellers of real estate.

To be considered for referrals, agents and their brokers agree to meet specific requirements, provide enumerated services, provide full disclosure statements, and generally to act in the best interest of the referred client. In return for the referral, the relocation service is remunerated for their matching and monitoring service through the commission received by the selling agent.

Akerlof points to private institutional forces as a means of assuring quality. He cites as examples: (1) guarantees, (2) brand-name goods, (3) chains, and (4) licensing. That Akerlof alludes to the role private institutions and entrepreneurship play in markets is laudable. That he gives such short shrift to market forces for self-regulation is not. Contrary to Akerlofs premise, markets serve to facilitate exchange between two or more individuals in an orderly process of human interaction; it is how and where relevant information is made known. With wants, behavior, and knowledge of market participants in constant flux, markets are more robust than how they are modeled in Akerlofs lemons model.

Markets incorporate a dynamic and evolutionary process whereby established standards, practices, and tools deemed to be the most efficient means of facilitating exchange today, are deemed inefficient tomorrow. Newer, more efficient standards, practices, and tools subsequently replace them. What is deemed efficient today becomes obsolete tomorrow, including means of maintaining social control. Social ordering, which encompasses a never-ending chain of human actions, can never be molded from a specific point in time, projected to carry forth into the future. Social interaction, including markets, entails an infinite number of individual actions based on individual knowledge of time and place.

Consequently, markets are not creatures of conscious human planning of their entire structure. Market processes emerge from a series of trial and error experimentations, derived from a progression of finding a more efficient means of facilitating exchange. The role of the entrepreneur is, by continually updating information, to discover more efficient means of promoting human interaction, thus facilitating exchange. No single individual can acquire the knowledge of time and place known only to each and every individual transacting in the market in order to enumerate specific rules and procedures of market behavior. The market and all of its rules are products of "human action, not of human design" (Hayek 1967).

To illustrate the robust nature of markets with regard to ameliorating potential problems in realizing the gains from exchange, we look at the market for used and out of print books that has emerged on the Internet.

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