Lemons Problem

AAA

DEFINITION of 'Lemons Problem'

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.

INVESTOPEDIA EXPLAINS '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. Clunker

    A popular reference to the old vehicle traded in under the U.S. ...
  2. Cash For Clunkers

    A program that allows car owners to trade in their old, less ...
  3. Lemon

    A very disappointing investment. A lemon is an investment in ...
  4. Adverse Selection

    1. The tendency of those in dangerous jobs or high risk lifestyles ...
  5. Asymmetric Information

    A situation in which one party in a transaction has more or superior ...
  6. Endowment Effect

    The endowment effect describes a circumstance in which an individual ...
RELATED FAQS
  1. No results found.
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. Investing Basics

    What Is The Impact Of Research On Stock Prices?

    The answer to this question is directly related to the importance of information in the marketplace.
  3. Investing Basics

    3 Essential Rules For New Investors

    Find out how beginner investors can invest sensibly, suitably and simply.
  4. Markets

    7 Signs A Stock Is Set To Slide

    In investment, knowledge is power. Knowing these signs could alert you to potential problems on the horizon for your stocks.
  5. Investing

    What Is The Real Picture Of Linn Energy?

    Numbers don't always tell the full story. Take, for example, the long-term chart for LINN Energy which was expected to be down more than 40%.
  6. Savings

    Top 10 Fastest Growing Industries in the United States

    Six of the ten fastest growing industries are directly related to new residential construction.
  7. Economics

    What's Demand Elasticity?

    Demand elasticity is the measure of how demand changes as other factors change. Demand elasticity is often referred to as price elasticity of demand because price is most often the factor used ...
  8. Budgeting

    4 Secrets You Should Know When Buying Groceries

    With a little foresight, every consumer can find ways to eat healthier without spending much money.
  9. Savings

    This Mysterious Job Saves You Money On Groceries

    Mystery shoppers visit various establishments. Discover how their efforts will save you money in the long run.
  10. Budgeting

    Ready To Save Money While Eating Healthy?

    These six cheap and nutritious foods are a perfect way to deal with rising grocery prices while staying healthy.

You May Also Like

Hot Definitions
  1. Gordon Growth Model

    A model for determining the intrinsic value of a stock, based on a future series of dividends that grow at a constant rate. ...
  2. Cost Accounting

    A type of accounting process that aims to capture a company's costs of production by assessing the input costs of each step ...
  3. Law Of Supply

    A microeconomic law stating that, all other factors being equal, as the price of a good or service increases, the quantity ...
  4. Investment Grade

    A rating that indicates that a municipal or corporate bond has a relatively low risk of default. Bond rating firms, such ...
  5. Fringe Benefits

    A collection of various benefits provided by an employer, which are exempt from taxation as long as certain conditions are ...
  6. Irrevocable Trust

    A trust that can't be modified or terminated without the permission of the beneficiary. The grantor, having transferred assets ...
Trading Center