In the market for used motorcycles there are high-quality motorcycles and low-quality motorcycles. Potential buyers cannot determine prior to purchase whether the motorcycle is high quality or low quality. Which of the following statements best describes what is likely to happen in this market?
A) The price of a used motorcycle will be very close to the value of a high-quality motorcycle, which will encourage people to sell high-quality motorcycles.
B) The price of a used motorcycle will be between the value of a high-quality and low-quality motorcycle. This will encourage people to withdraw high-quality motorcycles from the market.
C) This is an example of adverse selection, as the buyer will have more information about the quality of the used motorcycle than the seller will.
D) Over time the price of a used motorcycle will increase in this market, as there is more of an incentive for owners of high-quality motorcycles to sell than owners of low-quality motorcycles.

Question

Quizplus · Accepted Answer

This scenario is an example of the "lemons problem" described by George Akerlof, where the inability of buyers to distinguish between high-quality and low-quality goods leads to an average price that reflects neither. High-quality goods are undervalued and thus less likely to be offered for sale, while low-quality goods are overvalued, encouraging their sale. This results in a market where the quality of goods decreases over time, as high-quality items are withdrawn.

In the Market for Used Motorcycles There Are High-Quality Motorcycles