Nobel Prize, Economics, and Used Cars
Does the Study of Economics Deserve Its Own Nobel Prize?
Yuhong Qian
Issue date: 1/7/02 Section: GSB Business
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H0: Economics does not deserve a Nobel Prize.
Ha: not H0.
In 2001, Akerlof, Spence, and Stiglitz won the Nobel Prize "for their analyses of markets with asymmetric information". Coincidentally, Professor Michael Raith talked about this theory in our Microeconomics class last semester in a vivid manner. After I had seen an online discussion over the Nobel Prize in Economics, I felt that I was obliged to initiate a debate and any comments are welcome.
Asymmetric information and its application
Much of economic analysis assumes that markets are characterized by full information: both buyers and sellers know everything about the product they are buying or selling. However, many markets are characterized by the fact that either the buyer or the seller has considerably more information about the product than does the person or firm on the other side of the transaction.
George Akerlof illustrated the most famous example of asymmetric information in his 1970 paper on "The Market for Lemons". The paper examined the market for used cars to illustrate the importance of informational asymmetries. The scenario is quite simple - the seller of a used car usually knows more about it than does the buyer. They know, for example, how well it runs on the highway, in the snow, when it's hot outside, etc. The buyer knows relatively little. So if a seller offers to sell the car for, say, $5,000, the buyer should be suspicious, since, if the car were worth more than $5,000, the owner would not be selling it at that price. In this case, Akerlof showed that the market might break down completely.
This general idea can be used to explain many issues in many markets. Perhaps the most important market with significant asymmetric information is the market for health care. The buyer knows much more about her health and habits than does the insurance seller. For example, a company that offers a really good (but expensive) health policy will find that only the sick (or likely to be - say the smoker, the skydiver, and the race car driver) will buy that kind of insurance. Only those who expect to get more from the policy than they pay in premiums will be likely to purchase, meaning that the people who buy will be less healthy, and likely to make the policy unprofitable for the firm.
Ha: not H0.
In 2001, Akerlof, Spence, and Stiglitz won the Nobel Prize "for their analyses of markets with asymmetric information". Coincidentally, Professor Michael Raith talked about this theory in our Microeconomics class last semester in a vivid manner. After I had seen an online discussion over the Nobel Prize in Economics, I felt that I was obliged to initiate a debate and any comments are welcome.
Asymmetric information and its application
Much of economic analysis assumes that markets are characterized by full information: both buyers and sellers know everything about the product they are buying or selling. However, many markets are characterized by the fact that either the buyer or the seller has considerably more information about the product than does the person or firm on the other side of the transaction.
George Akerlof illustrated the most famous example of asymmetric information in his 1970 paper on "The Market for Lemons". The paper examined the market for used cars to illustrate the importance of informational asymmetries. The scenario is quite simple - the seller of a used car usually knows more about it than does the buyer. They know, for example, how well it runs on the highway, in the snow, when it's hot outside, etc. The buyer knows relatively little. So if a seller offers to sell the car for, say, $5,000, the buyer should be suspicious, since, if the car were worth more than $5,000, the owner would not be selling it at that price. In this case, Akerlof showed that the market might break down completely.
This general idea can be used to explain many issues in many markets. Perhaps the most important market with significant asymmetric information is the market for health care. The buyer knows much more about her health and habits than does the insurance seller. For example, a company that offers a really good (but expensive) health policy will find that only the sick (or likely to be - say the smoker, the skydiver, and the race car driver) will buy that kind of insurance. Only those who expect to get more from the policy than they pay in premiums will be likely to purchase, meaning that the people who buy will be less healthy, and likely to make the policy unprofitable for the firm.