ABSTRACT
Akerlof (1984) postulates the failure of markets in which asymmetric information between buyers and sellers leads to adverse selection in the quality of goods sold in such markets. In the absence of an intervening mechanism to correct information problems, the incentive exists for sellers of relatively low quality goods to promote their wares as being of higher quality; the gains to unscrupulous sellers from misrepresenting their products are externalized on to other sellers in the market in the form of lower subsequent prices. Adverse selection, therefore, leads to declining average quality of goods in markets rife with asymmetric information. Prospective buyers accordingly lower their expectations of average quality, and consequently, the prices they are willing to pay. These lower prices force sellers of higher quality goods – unable to credibly signal the superior quality of their goods in order to exact a price above their reservation price – to exit the market. As this cycle is repeated, the market becomes increasingly saturated with lower quality goods and the market disappears, if it materializes at all.
