Market of Lemons in Healthcare
When Healthcare is a “Lemon”: Asymmetric Information and Market Failure
The market of lemons is a concept proposed by George Akerlof, who explores the scope of economic trade beyond perfect competition. Based on the existence of asymmetric information, the market of lemons won Akerlof a Nobel Prize. In the particular example of lemons, there are cars and lemons on the market. Only the sellers know which of the two is for any specific item but not the buyer. However, regardless of their different kinds, cars and lemons are sold at the same price. Due to the uncertainty of quality from the buyers’ perspective, there potentially can be a market failure. The reason is that the buyers are obviously not willing to pay the price of a car and get a lemon. For example, buyers have expected value of 100 for each car and 1 for each lemon, and the sellers are willing to sell at these prices as well. However, because it is equally likely to receive a car or a lemon, the buyers’ willingness to pay is (100+1) /2 = 50.5 for each item they are uncertain of what it is. As a result, car sellers will not accept this price and no cars will be sold on the market.
This concept has some realistic and significant applications in the real world too. Healthcare is one such example. In this case, insurance companies do not know the exact conditions of their customers while the customers know themselves. In the context of healthcare, customers with more serious conditions are willing to pay higher price for the insurance as they anticipate more expensive medical bills. Insurance companies, on the other hand, want to make profits. As a result, they set high premiums as well as try not to sell to sicker customers. These measures have caused the healthcare market to fail. Average americans who might not need as many coverages cannot afford the high premium while people who need the coverage the most are denied of insurance.