Date:21/08/2005 URL: http://www.thehindubusinessline.com/bline/iw/2005/08/21/stories/2005082100321300.htm

Back Second-hand goods

B. Venkatesh

RECENTLY, my friend had a first-hand experience of how economics works in everyday life. He decided to sell his two-month old car, as his company was sending him abroad for a year. Unfortunately, none were willing to pay more than 75 per cent of the price of a new car. Why did the buyers want a high discount for a relatively new car?

The answer lies in information asymmetry. It simply means that one person has more knowledge about a transaction than the other.

The seller typically has more information about a product than the buyer. This makes the buyer suspect that the seller is dumping a low-quality product on him. The suspicion will be higher when a relatively new product enters the second-hand market.

So, no amount of explanation that my friend gave convinced any of the buyers to increase their price. He later found that the price that the buyers were willing to pay was not substantially higher than that for a one-year old car.

My friend, therefore, decided to retain the car for sometime, hoping to sell it at a reasonable price at a later date. The market behaviour that my friend experienced is, of course, not new.

George Akerlof, a professor at the University of California, Berkeley, won the 2001 Nobel Prize for his work on market asymmetry. He showed that the market becomes filled with low-quality products when the sellers have more information than the buyers. Why?

Buyers are unwilling to pay a reasonable price for a good quality product when they find it difficult to determine the product quality. It is, therefore, in the sellers' interest to peddle low-quality products for the same price. By deciding to sell his car later, my friend was attempting to do just that.