Showing posts with label Akerlof. Show all posts
Showing posts with label Akerlof. Show all posts

Friday, February 24, 2012

Why You Can Rarely Find A Decent Second Hand Bike?

I have been planning to buy a motor bike ever since I moved out of college. I started shortlisting some of the models 2 months back keeping in mind that the bonuses season was fast approaching. The excitement was all there and everything was in place except, of course, the required moolah. The day finally came, lightning struck, and I was left wondering whether I can afford a bike or not. This led me to start considering  the option of buying a used bike. I spent my last one week looking for a decent bike which would provide some good value for money. But naaah..nothing seemed to click. This reminded me of a great explanation which an economist George Akerlof published in 1970. Let me try to explain that you in this post.

Imperfect Info Playing Spoilsport??

Lets assume that I am willing to buy a bike for anything less than, say, 70 Rs. This means I value the bike no more than 70 Rs. To strike a deal, I need to find some one who owns that bike and considers its value as less than 70. The whole procedure sounds good since I think there would be plenty of guys who would be willing to sell their bike for for say, 45 Rs. For the sake of simplicity let me assume that all bikes are of the same brand and make. Also, let me assume that either a bike is well maintained and worth 70 Rs to the buyer, Or it is ill maintained and worth zero Rs to the buyer. I am taking extreme figures just to make things less complicated and am sure this would not affect the conclusion. Now here is the twist. Whether the bike is worth 70 Rs is some thing that I would know only when I have used it for a considerable amount of time. If I assume that half of all bikes are ill maintained, then I have just 1/2 probability of getting a decent bike if selected at random. If I behave rationally, I would be willing to pay 70/2 i.e. 35 Rs for a bike since the chances of it being worth 70 are 50%. The seller of the bike on the contrary already knows whether the bike is well maintained or not. Since he values his well maintained bike at 45 Rs he would never be willing to sell it for 35. Hence I will not have any decent bikes for offer. The only offers I will get will be from sellers who already know that their bikes are worth nothing. This would again reduce the probability of getting a good bike to much less than 50% and I would be forced to bid for even lesser that 35. This will go on and hence I would never be able to find a decent second hand bike for the amount of money I am willing to pay.
This phenomenon arises because of imperfect information or rather imperfect distribution of information. The seller knows far more than what I know and this will eventually lead to the vanishing of whole market altogether. Imperfect information is again the cause of problems in insurance industry and high premiums that we have to pay for health insurance. In the later case its the buyer of health insurance who has relatively more information than the seller.
The only solution that exists in such cases is to reduce the gap of information between a buyer and seller by educating the one with less information. We do have some companies doing this in India who check used cars/bikes throughly and then explain to the buyer the true value of the used automobile. These companies come in the form of preowned car companies like Mahindra First Choice and will play an important role in keeping the used cars/bikes market alive. But as of now, my search for a good bike is still on.