Lemon Markets

I just got this from Schneier:

In 1970, American economist George Akerlof wrote a paper called "The
Market for 'Lemons,'" which established asymmetrical information theory.
He eventually won a Nobel Prize for his work, which looks at markets
where the seller knows a lot more about the product than the buyer.

Akerlof illustrated his ideas with a used car market. A used car market
includes both good cars and lousy ones (lemons). The seller knows which
is which, but the buyer can't tell the difference -- at least until he's
made his purchase. I'll spare you the math, but what ends up happening
is that the buyer bases his purchase price on the value of a used car of
average quality.

This means that the best cars don't get sold; their prices are too high.
Which means that the owners of these best cars don't put their cars on
the market. And then this starts spiraling. The removal of the good cars
from the market reduces the average price buyers are willing to pay, and
then the very good cars no longer sell, and disappear from the market.
And then the good cars, and so on until only the lemons are left.

In a market where the seller has more information about the product than
the buyer, bad products can drive the good ones out of the market.

I think this explains a whole lot of things. I have seen it in stereo components, in political debate, in enterprise software (to a certain extent), in web analytics, in theology and even in the diet and exercise business. It's absolutely fascinating. I will use the Lemon Market Theory going forward.