Tuesday, March 1, 2011

Privacy and the Invisible Hand

by Robert Hahn and Peter Passell

February 28, 2011

Some four decades ago, Nobel economist George Akerlof argued that markets didn’t get it right when sellers knew a lot more than their potential customers. In the used car market, for example, buyers can’t readily distinguish lemons from non-lemons without investing in the services of an independent mechanic. So they are forced to assume the worst. Bad cars, in effect, drive the good ones from the market, leaving both buyers and sellers worse off.

To many economists, this problem of “asymmetric” information constituted a solid justification for regulating car sales. State legislators agreed, passing a spate of laws that guaranteed buyers the right to return lemons. But this consumer protection was hardly free: it added to the cost of transactions in the used car market.

What nobody noticed at the time, though, was that one man’s market failure was another’s market opportunity. CarMax pioneered the used-car guarantee, which finessed the information problem. And many other used car dealers followed suit.

These dealers have a strong incentive to discover faults and repair them before they put them up for sale. Of course, guaranteed cars sell for higher prices. But that’s just the point: the market found a way to separate the good cars from the bad ones.

Why are we telling you this? Because, given a little time, markets have a way of fixing themselves in more situations than you might imagine.


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