The Market for Lemons

The market for Lemons is an interesting phenomenon where if the number of bad/low quality products start to fill up a market, the it lowers the value for all of those involved in that market because distinguishing between a good and bad product is hard, so instead the value is assigned the average quality of the market. Eventually, this means above average quality prices only fetch average prices so they are driven out, lowering consumer expectations and prices, which drives out the next highest tier of quality until only bad products are left.

For me, this is one of the best cases to avoid races to the bottom and focus on a race to the top. Imagine the inverse of the Market for Lemons. A new class of products is introduced to the market, raising customer expectations and as a result prices. An average product now receives a price above what it did previously. Hopefully, using that increased price difference it is reinvested at least partially, say 50%, into improving the products again, which continues the cycle of raising expectations and prices, making everybody more profitable.

Something to note about the Market for Lemons is that it is based on information asymmetry. The seller knows the quality, but for something like a used car, the buyer has to take a leap of faith. As a result, there is a beautiful irony. When we often talk about a shady salesman, we talk about acting like a “used car dealer.” That means these salesman, while thinking they are optimizing for their own pockets by not being forthcoming lower the trust in their industry making it less profitable as people now expect to have to repair things that they weren’t told about, so they revise their offers downward.

Races to the bottom never pay off, and trust always does. Spend some time to building that, and if you can try to convince your industry to adopt that mindset too.

Here’s a link to learn more about the Market for Lemons if you would like: