George Akerlof and the Internet

["Ang Peng Hwa (Assoc Prof)" <TPHANG@ntu.edu.sg>]

Folks,

I just learnt that someone I had cited in a recent paper concerning the Net
has won the latest Nobel Prize for Economics. He is George Akerlof, 61, of
UC Berkeley and his classic study is a 1970 paper on "a market for lemons".
["The Market for 'Lemons': Quality Uncertainty and the Market Mechanism,"
Quarterly Journal of Economics (August l970).] I thought folks on this list
might be interested to know of its applicability to the 'Net. 

The paper is titled "Code of Practice For Internet Content Self-Regulation"
and was commissioned by the Asia and Pacific Internet Association
(apai.org). This is what I said of Akerlof's study:

"It is frequently said that the 'Net is free and should be free. Adopting
this position without qualification raises some issues: how does anyone know
the quality of information, goods or services being provided. In short, the
free nature of the Internet raises the question of quality uncertainty.
"What happens in a market where the quality is uncertain? A now-classic
study by Akerlof (1970) on quality uncertainty suggests that there could
emerge 'a market for lemons' or poor quality goods that would eventually
drive out high-quality producers and, in the extreme, destroy the market.
"Here is how Akerlof's analysis would apply to the web. A website's
offerings-goods, information or services-are marked by asymmetric
information. The consumer does not have the same information as the seller.
Consumers cannot judge its quality. If consumers cannot reliably judge
quality, trust is the only factor to allow economizing on information costs.
Because consumers cannot view the quality of the service, no consumer will
accept paying a price higher than 'normal'. Producers with a high-quality
service would therefore not be willing to sell at that same price.
"Akerlof concludes that asymmetric information reduces (1) the volume of
transactions and (2) the average quality of goods and services exchanged.
Such a situation where high quality goods and services are penalized is
known as 'adverse selection'.
"As a result of asymmetric information, information providers are not able
to signal quality differences to the buyers. The market does not punish
sellers of low quality goods and services (unless the buyer is a large or
regular customer) because the market does not know that these are
low-quality producers. The market price will reflect only the average
quality level and therefore attract average quality sellers. This leads to a
perception by the consumer of a reduction in the average quality, which
leads to a further reduction of market price and another round of lowering
of average quality.  This process is cumulative and in the extreme, destroys
the market altogether.
"Akerlof's model applies to goods and services regardless of the risks
associated with them. Of course, if the risks are trivial, the market may
continue to function. The two solutions that would develop a market under
such conditions would be to sell products for which quality is known (such
as books) or to create a mechanism that inculcates trust. The latter
solution, creating trust, is today called branding. It is possible to
achieve branding with a self-regulatory device such as a trustmark. Such
trustmarks are in use today on a variety of goods ranging from oranges to
clothes and on any service carrying the ISO (International Organisation for
Standards) mark."

Akerlof's webpage is: http://emlab.berkeley.edu/users/akerlof/

Regards,
Peng Hwa

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