The Market for Lemons - Definition and Overview

"The Market for Lemons: Quality Uncertainty and the Market Mechanism" is a paper by George Akerlof written in 1970 that established the fundamentals of asymmetrical information theory. Akerlof, a professor at the University of California, Berkeley, won the Nobel Prize of Economics in 2001 for his research. It describes adverse selection.

The paper describes the second-hand market for used cars. Some cars are in good working order — these are referred to as cherries, peaches, or jewels. Some have hidden defects — these are called lemons. Yet because buyers don't know which cars are the lemons — under asymmetric information —, in an effect that is known as crowding out, the market price of even the good cars decreases. Thus, sellers of the cherries are less inclined to sell their cars, and even a competitive market will only be filled with bad cars.

The term "lemon," meaning a defective (typically used) car, entered the language of economics as a result of this paper.

Reference

Akerlof, G. (1970). The market for lemons: quality uncertainty and the market mechanism. Quarterly Journal of Economics 84 (3), 488-500.