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Limits to the «theorem of lemons»: demand for good cars under equilibrium price dispersion

Malakhov, Sergey (2018): Limits to the «theorem of lemons»: demand for good cars under equilibrium price dispersion.

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The model of equilibrium price dispersion examines the demand for cars through the optics of the demand for mileage where the asymmetry of information is produced by the odometer fraud. Theoretically, fraudsters can destroy the market as it is described by the “theorem of lemons”. But the market self-deactivation does not take place. The purchase of a car with regard to the demand for mileage represents a form of home production where driving like gardening and pets’ care provide a direct utility but is also something one can purchase on the market. At the margin nobody buys but everybody gets taxi. The increase in taxi price per mile raises the demand for good cars of taxi drivers and it makes rational for potential buyers to pay for taxi drivers expertize fee in order to choose a good car. The demand for good cars is restored at the new price level. The pessimistic scenario, however, doesn’t take place because good cars stay attractive. The equilibrium price of a mile establishes the direct relationship between marginal savings on purchase and the time horizon of the consumption-leisure choice. Great discounts provide potential buyers the additional information about short life cycle of vehicles like unexpected low price for beefsteak tells about its short shelf life. The equilibrium price of a mile describes also the trade-off between the purchase price and the costs of ownership. The marginal approach does not rely on the endowment effect. The choice between a good car and a bad car discovers the willingness to take care of good cars where the after-the-purchase costs of ownership per mile become greater than for a bad car. The willingness to take care of the big-ticket quality items reinforces the willingness to pay of potential buyers, and sellers of good cars do not quit the market.

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