"The Market for Lemons" and Its Implications

An article by Bruce Schneier in Wired Magazine, “How Security Companies Sucker Us With Lemons,” which we found thanks to Slashdot, discusses the work of Nobel Prize winning economist George Akerlof on markets with asymmetrical information:

Why are there so many bad security products out there? It’s not just that designing good security is hard — although it is — and it’s not just that anyone can design a security product that he himself cannot break. Why do mediocre security products beat the good ones in the marketplace?

In 1970, American economist George Akerlof wrote a paper called “The Market for ‘Lemons’” (abstract and article for pay here), which established asymmetrical information theory. He eventually won a Nobel Prize for his work, which looks at markets where the seller knows a lot more about the product than the buyer.

Akerlof illustrated his ideas with a used car market. A used car market includes both good cars and lousy ones (lemons). The seller knows which is which, but the buyer can’t tell the difference — at least until he’s made his purchase. I’ll spare you the math, but what ends up happening is that the buyer bases his purchase price on the value of a used car of average quality.

This means that the best cars don’t get sold; their prices are too high. Which means that the owners of these best cars don’t put their cars on the market. And then this starts spiraling. The removal of the good cars from the market reduces the average price buyers are willing to pay, and then the very good cars no longer sell, and disappear from the market. And then the good cars, and so on until only the lemons are left.

In a market where the seller has more information about the product than the buyer, bad products can drive the good ones out of the market.

Schneier goes on to tell us how the computer security market has many characteristics in common with the used car example. Readers can probably think of other examples.

I’d like to carry Akerlof’s idea one step further. In a recent post, we discussed Maggie Mahar’s book, Market-Driven Medicine, and, among other things, it discusses how asymmetrical information allows the sell side of the health care industry to genera†e excessively high revenues. Even if you’d like have consumers bear a higher proportion of health care costs in the hope that they will make better choices, they lack the knowledge to do so. In some fields, such as oncology, it’s a near impossibility for doctors to keep on top of the medications.

So here we have several layer of asymmetry. Many (most?) doctors don’t have time to keep up on research, and so are influenced by marketing. And even when patients are able to investigate their treatment options, some doctors are resistant to patient ideas (and in turn, many patients lack the financial resources and time it takes to shop for a doctor who is more participative). So you have the situation where the doctors are (in many cases) better informed than the patients, but perhaps not as well informed as they think they are (i.e., they do not recognize the degree to which their view of the pros and cons of treatment options has been influenced).

A simple example: mammograms. Many studies have questioned whether mammograms are an effective test, in terms of improving survival rates for women with breast cancer. Even though mammograms arguably detect cancer earlier, they are good at detecting the slow-moving cancers that are not life threatening (meaning if one waited to treat them, there would be little, if any, change in mortality) and bad at detecting the fast growing cancers that are deadly. One study of the histories of 500,000 women in four countries found that for the one in 2000 who would have her life extended, another ten would be subject to unneeded, and potentially dangerous, treatments. Similarly, Malcolm Gladwell in a New Yorker article, “The Picture Problem,” pointed out how some studies have found skilled manual examination to be just as effective as mammogram, at considerably lower cost. But it’s dogma in the US that women over 50 should have an annual mammogram, despite the dubious value of the test. And doctors are deeply invested in that point of view. Is it because radiologists have purchased expensive equipment and are good at rationalizing their technology choices? Or is something more complicated at work?

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