Bandana Preet Kaur Jolly
A market appears to be a simple institution where buyers and sellers exchange commodities to enhance economic growth but in reality we fail to realise the dysfunctionalities that actually can disrupt such a transaction and lead to a market failure. A market is usually portrayed as an equilibrium state but this is a Utopian state- far from reality. The causes attributed to such a market failure are quite a few like dominance of market power by a few, public goods, asymmetry information and equity. The existence of asymmetry information is easy prone to market failure by way of adverse selection. Asymmetry information is a situation whereby one party has a greater advantage over another in terms of accessibility of market information. In such cases the buyers are the ones who are the ignorant lot and the sellers are the ones who have information more than what they need which ultimately gives the latter an advantage to sell inferior quality goods to the former without they being aware about it. This eventually gives rise to the Lemon Problems Theory described by George Akerlof which explains how asymmetric information provides incentives for sellers of low quality goods to present their products as high quality goods thus reducing overall product quality and consumer satisfaction. This report gives a gist of the various causes of market failure with greater focus on asymmetry information. It seeks to give an insight and understanding of how asymmetric information via the Lemons Problem Theory can lead to a market failure with special reference to the purchase of a car or an insurance policy. It explains in detail the concept of adverse selection as an example of asymmetry information and finally soughts to give solutions to the Lemons Problem.
Market Failure