Awards and Honors

The Market for Lemons

Berkeley's new Nobel Prize economist wins for explaining asymmetric information in the marketplace, a notion that has had profound effect on theories of behavioral economics.

George Akerlof. Noah Berger photo.

By Diane Ainsworth and Jeff Holeman

Fall 2001 | He didn't coin the term "lemon," but whenever consumers get stuck with one—whether it's a used car, a faulty appliance or an inadequate health care insurance policy—Berkeley economist George A. Akerlof's Nobel Prize-winning theory comes alive.

A co-winner of the 2001 economics prize, Akerlof first introduced the notion of "asymmetric information" as a factor in the performance of some markets in his landmark study in 1970. His ideas, based on a study of the market for "lemon" used cars, broke with established economic theory by illustrating how markets malfunction when buyers and sellers operate using different information. The work has had far-reaching applications in such diverse areas as health insurance, financial markets and employment contracts.

Akerlof, 61, is UC Berkeley's 18th Nobel Prize winner. This was the second consecutive year in which a Berkeley professor won the economics prize.

Akerlof is married to Berkeley economics professor Janet L. Yellen, who chaired the U.S. Council of Economic Advisers under former President Bill Clinton and was a member of the Board of Governors of the Federal Reserve System. Akerlof and Yellen have worked together on numerous research projects. Their son Robert, 20, is majoring in economics and math at Yale.

A native of New Haven, Conn., Akerlof developed a keen interest in economics as a child growing up in the shadow of the Great Depression.

"I've always been interested in why people are poor," he said. "What economics is about is trying to prevent poverty insofar as that is possible."

In his theory of asymmetrical information, one side of the economic equation—either the buyer or the seller—has more information than the other. When the seller has more information, for instance, he will have the upper hand and can skew the outcome of the sale. The seller may know that the car he wants to sell is a lemon; the buyer can only hope that it is not.

Akerlof's insights can be applied to other markets as well, such as the health insurance industry. A person without medical insurance who develops a serious illness and wants to buy insurance might not disclose his condition to prospective insurers. The companies' financial viability, however, depends on having a balance of healthy and sick clients. Such information imbalances can cause markets to break down and lead to a lowering of the quality of products for all consumers, said Alan Auerbach, chair of the economics department.

"In the years since that paper," Auerbach said, "we've realized how pervasive these problems are and how important this research has been. This work is fundamental to our understanding of market failures."

Akerlof shares the prize with Joseph Stiglitz of Columbia University and Michael Spence of Stanford University. The three will split the $945,000 prize that comes with the award, which will be presented in a ceremony in Stockholm.