:QUALITY UNCERTAINTY AND THE MARKET MECHANISM * GEORGE A. AKERLOF QUARTALY JOURNAL OF ECONOMICS　1970　　　�T.Introduction　488.-　�U.The model with automobiles as an example　489.-　�V.　Examples and applications　492.-　�W.Counteracting　institutions　499.-　�X．Conclusion　500.　　 �T.INTRODUCTION 　This paper relates quality and uncertainty. The existence of goods of 　many grades poses interesting and important problems for the theory ofmarkets. On theone hand 　the interaction of quality differences and 　uncertainty may explain im-portant institutions of the labor market. On the other hand 　this paper presentsa struggling attempt to give structure to 　the statement: "Business in underde- veloped countries is difficult"; in particular 　a structure is given for deter- mining the economic costs of 　dishonesty. Additional applications of the theory include comments on the structure of money markets on thenotion of "insurabili-ty on the liquidity of durables 　and on brand-name goods. There are many mar- kets in 　which buyers use some market statistic to judge the quality of prospec- 　tive purchases. In this case there is incentive for sellers to market poor qual-ity merchandise 　since the returns for good quality accrue mainly to 　the entire group whose statistic is affected rather than to the individual 　seller. As a re-sult there tends to be a reduction in the average quality 　of goods and also in the size of the market. It should also be perceived 　that in these markets socialand private returns differ and therefore in some cases 　governmental interven-tion may increase the welfare of all 　parties. Or private institutions may arise to take advantage of the 　potential increases the welfare of all parties. Or pri-vate institutions 　may arise to take advantage of the potential increases in wel-fare which can accrue to all parties. By nature however these institutions arenonatomistic 　and therefore concentrations of power−with ill 　consequences of their own−can develop. 　*The author would especially like to thank Thomas Rothenberg for 　invaluable comments and inspiration. In addition he is indebted to Roy Radner Albert Fishlow Bernard Saffran William D. Nordhaus Giorgio LaMalfa Charles C.Holt John Letiche and the referee for help and 　suggestions. He would also like to thank the Indian statistical Institute 　and the Ford Foundation for financial support. 　The automobile market is used as a finger exercise to illustrate and 　developthese thoughts. It should be emphasized that this market is chosen 　for its con- creteness and ease in understanding rather than for its importance or realism. 　�U．THE MODEL WITH AUTOMOBILES AS AN EXAMPLE A.The Automobiles Market 　The example of used cars captures the essence of the problem.From time to 　time one hears either mention of or surprise at the large price difference 　be- tween new cars and those which have just left the showroom. The usual 　lunch ta- ble justification for this phenomenon is the pure joy of owing a 　new" car. We offer a different explanation. Suppose (for the sake of 　clarity rather than re- ality) that there are just four kinds of cars. 　There are new cars and used cars.There are good cars and bad cars(which in 　America are known as "lemons"). A new car may be a good car or a lemon and 　of course the same is true of used cars. 　The individuals in this market buy a new automobile without knowing 　whether the car they buy will be good or a lemon. But they do know that 　with probabilityq it is a good car and with probability(1−q) it is a lemon; by assumption 　q isthe proportion of good cars produced and (1−q) 　is the proportion of lemons. Af-ter owning a specific car however for a length of time 　the car owner canform a good idea of the quality of this machine; i.e. 　the owner assigns a new proba-bility to the event that his 　car is a lemon. This estimate is more accurate thanthe original estimate. 　An asymmetry in available information has developed: for the sellers now 　have more knowledge about the quality of a car than the buyers. But good 　cars and bad cars must still sell at the same price−sinceit is impos- 　sible for a buyer to tell the difference between a good car and a bad car. 　It isapparent that a used car cannot have the same valuation as a new car−if it did have the same valuation it would clearly be advantageous to 　trade a lemon at the price of new car and buy another new car at a 　higher probability q of be- ing good and a lower probability of being bad. 　Thus the owner of a good machine must be locked in. Not only is it true 　that he cannot receive the true value of his car but he cannot even obtain the expected value of a new car. 　Gresham's law has made a modifide reappearance. For most cars traded will be the "lemons 　and good cars may not be traded at all. The bad" cars 　tend to drive out the good (in much the same way that bad money drives 　out the good). But the analogy with Gresham's law is not quite complete: 　bad cars drive out thegood because they sell at the same price as good cars; similarly 　bad money drives out good because the exchange rate is 　even. But the bad cars sell at the same price as good cars since it is 　impossible for a buyer to tell the differ- ence between a good and a bad 　car; only the seller knows. In Gresham's law how-ever presumably both 　buyer and seller can tell the difference between good and bad money. So the analogy is instructive but not complete.