Lemons Problem

What is the 'Lemons Problem'

The lemons problem is the issue of information asymmetry between the buyer and seller of an investment or product. Lemons problem was popularized by a 1970 research paper by economist George Akerlof. The term is derived from Akerlof's demonstration of the concept of asymmetric information through the example of defective used cars, which are known as lemons in marketplace. In the investment field, the lemons problem is apparent in areas such as insurance and corporate finance.

BREAKING DOWN 'Lemons Problem'

Information asymmetry arises when the parties to a transaction do not have the same degree of information necessary to make an informed decision. For example, in the market for used cars, the buyer generally cannot ascertain the value of a vehicle accurately and may therefore only be willing to pay an average price for it, somewhere between a bargain price and a premium price.



However, this tilts the scales in favor of a lemon seller, since even an average price for this lemon would be higher than the price it would command if the buyer knew beforehand that it was indeed a lemon. This phenomenon also puts the seller of a good used car at a disadvantage, since the best price such a seller can expect is an average price, and not the premium price the car should command.

RELATED TERMS
  1. Lemon

    A very disappointing investment. A lemon is an investment in ...
  2. Lemon Laws

    Regulations that attempt to protect consumers in the event that ...
  3. George A. Akerlof

    A winner of the 2001 Nobel Prize in Economics, along with Michael ...
  4. Plum

    A choice investment, or one that has outperformed other comparable ...
  5. Asymmetric Information

    A situation in which one party in a transaction has more or superior ...
  6. Buyer's Market

    A situation in which supply exceeds demand, giving purchasers ...
Related Articles
  1. Budgeting

    How To Avoid Buying A "Lemon" Product

    A lack of information can lead people into bad purchases and bad investments. Find out how you can avoid these lemons.
  2. Home & Auto

    Did You Buy A Lemon?

    Find out how to fix a sour deal on your car purchase.
  3. Home & Auto

    Used Car Shopping: How To Avoid A Lemon

    Being prepared before buying will save you thousands in the long run.
  4. Home & Auto

    7 Mistakes to Avoid When Buying a Used Car

    Understand the benefits of buying a used car. Learn about seven mistakes to avoid before making a used car purchase.
  5. Home & Auto

    Ins And Outs Of Seller-Financed Real Estate Deals

    Seller financing works like this: Instead of a buyer receiving a loan from a bank, the person selling the house lends the buyer the money for the purchase.
  6. Insurance

    How Car Insurance Companies Value Cars

    Learn the methodology used by car insurance companies to value cars, and understand why the amount they give you may not cover the cost of a similar vehicle.
  7. Investing Basics

    How To Get A Good Deal On A Used Car

    Why are prices quoted by dealers and private sellers so disparate? Read on to find out how to use that info to your benefit when buying a used car.
  8. Home & Auto

    Car Payments: 'Til Death Do Us Part

    Your car breaks down... You head to the dealership, ready to replace it with something more reliable. But the dealership has a few tricks up their sleeve...
  9. Options & Futures

    Investment Services Stump Investors

    What you're getting isn't easy to determine. Find out how to get your money's worth.
  10. Credit & Loans

    How Risky Are Long-Term Car Loans?

    A look under the hood of long-term car loans.
RELATED FAQS
  1. What is the theory of asymmetric information in economics?

    Read a brief overview of asymmetric information theory in economics, the development of its main arguments and why some challenge ... Read Answer >>
  2. Do any markets not exhibit asymmetric information?

    Find out why every market possesses information asymmetry, and why this isn't necessarily a huge or insurmountable problem ... Read Answer >>
  3. How significant is asymmetric information risk?

    Learn about the presence of asymmetric information risk in the financial markets and how various parties present or are exposed ... Read Answer >>
  4. How does adverse selection contribute to market failure?

    Examine an brief introduction to the adverse selection theory of market failure, and find out why economists disagree about ... Read Answer >>
  5. How do financial market exhibit asymmetric information?

    Understand how financial markets exhibit asymmetric information. Learn how asymmetric information by any party can result ... Read Answer >>
  6. When buying a car, is it better to have a trade in or a down payment?

    When buying a car, it may be better to have a down payment rather than a trade in. A trade in offers convenience to the car ... Read Answer >>
Hot Definitions
  1. Reverse Mortgage

    A type of mortgage in which a homeowner can borrow money against the value of his or her home. No repayment of the mortgage ...
  2. Labor Market

    The labor market refers to the supply and demand for labor, in which employees provide the supply and employers the demand. ...
  3. Demand Curve

    The demand curve is a graphical representation of the relationship between the price of a good or service and the quantity ...
  4. Goldilocks Economy

    An economy that is not so hot that it causes inflation, and not so cold that it causes a recession. This term is used to ...
  5. White Squire

    Very similar to a "white knight", but instead of purchasing a majority interest, the squire purchases a lesser interest in ...
  6. MACD Technical Indicator

    Moving Average Convergence Divergence (or MACD) is a trend-following momentum indicator that shows the relationship between ...
Trading Center