Friday, January 18, 2008

When life gives you lemons... Make lemonade!

Some markets turn out to be very interesting. Last week I talked about banks and mortgages in the U.S.: consumers need to be Masters in Law to understand which mortgage is the right one for them. An other interesting theory that can be applied to many markets is ‘the market for lemons’.

There are four type of cars: new cars and used cars, good cars and bad cars. A new car can either be a good car or a bad car, just like a used car. In the U.S., bad cars are called lemons (which comes from the said “when life gives you lemons, make lemonade”; or: when life is turning sour, find something sweet to make the best out of it). A buyer of a car does not know whether a car is a good car, or a lemon; the buyer is only able to estimate the chance that a car is good (based on previous experience or information from other people).

Let’s take for example a dealer that has two cars, that look exactly the same: a 1999 Mercury Mystique. The value of a good make would be around $ 3.600 (, while the value of a lemon would be around $ 1.500 (you might be able to drive it for a while). However, when a car dealer wants to sell both models, he’d probably never get rid of the lemon when he uses these prices (the buyer would know that it’s a lemon) so he would try to get the most out of it: he sells both cars for $ 2.900. This is called information asymmetric: the seller knows more than the buyer knows. This theory can be applied to many markets, e.g. MP3 players that are hacked so they look like they have more memory, they are sold on the internet and the buyer finds out that he can’t use all the memory when he first tries to copy music to the player.

When I got at my car dealer last week, the $ 1.500 Mercury Mystique from 1999 looked pretty nice! (forgetting all the lessons I learned about lemon markets in University.) Indeed, it turned out to be a lemon. $ 800 repair costs fixed the major problems, hopefully it will run for a while. Pictures coming soon! Some other updates from my personal life:
• Starting February, I will be part of the ING Direct soccer team! Only the outdoor season doesn’t start until June (!) so we’ll be playing indoor till then.
• The weather changes a lot over here: on one evening you’re walking outside in a shirt feeling like it is the end of a nice summer day, the next day it snows…
• This weekend is filled with some nice parties: Saturday something called ‘Pot Luck’ (everybody brings some food or beverages, they are combined for dinner) and Sunday I’ll be watching an American Football game (not to be confused by Football – they call it soccer over here), as a housewarming party of a colleague.

Thanks for all your e-mails, unfortunately my notebook crashed last week so sorry for the late replies!

PS. Do I belong to the target group of this video?