Lemon Market Theory

Acronym
LMT

Alternate name(s)
Lemon Theory

Main dependent construct(s)/factor(s)
Market deterioration in markets with information asymmetry

Main independent construct(s)/factor(s)
- Price of product - Acclaimed product quality by selling party - Expected/perceived product quality by buying party - Actual quality of the product - Average market price of the product

Concise description of theory
In 1970 George Akerlof published a ground breaking paper about the consequences of information assymetry. The full title is : 'The Market for Lemons: Quality Uncertainty and the Market Mechanism'.

In markets where it is impossible to asses the quality of a product/service, where, so to say the seller of the product has more information than the buyer, the market will gradualy deteriorate and maybe even eventually dissapear altogether.

The main issue is that quality is unassesible beforehand, thus giving sellers incentives to present the product/service as being of higher quality than it actually is. The buyer, however, knows this and will take the average quality of the market into consideration. This will have as a result that high quality products/services will leave the market, since they will only sell for average market quality goods.

Therefore the average market quality will deteriorate and the market will shrink.

The paper also talks about the 'cost of dishonesty'. The cost of dishonesty, therefore, lies not only in the amount by which the purchaser is cheated; the cost also must include the loss incurred from driving legitimate business out of existence.

The name is derived from the main example Akerlof uses in his paper. He explains his theory with the used cars market, in which a bad car is called a 'lemon'.

Diagram/schematic of theory
N/A

Originating author(s)
George Arthur Akerlof

Originating area
Economics

Level of analysis
Market, individual firms

IS articles that use the theory
Backhouse, J., Hsu, W.Y., Tseng, J., Baptista, J. (2005) "A Question of Trust - An economic perspective on Quality Standards in the Certification Services Market". Communications of the ACM. September, ISSN 0001-0782

Links from this theory to other theories
Agency theory Adverse selection Moral hazard

Original Contributor(s)
Bart Verplancke        mailto:bart.verplancke@howest.be Jan Devos               mailto:jan.devos@howest.be Please feel free to make modifications to this site. In order to do so, you must register. Return to Theories Used in IS Research