Economics and Fallibility
By Bryan Caplan
When students first hear about the famous Akerlof’s “lemons model,” they almost invariably misinterpret it. “Aha,” they think, “this is why used car dealers get rich ripping off unsuspecting customers.” The true point, of course, is that asymmetric information makes customers suspicious, leading to lower demand, prompting reliable sellers to leave the market, which in turn intensifies customer suspicion.
Only recently, though, did I discover an especially excellent textbook discussion of this point. From McCloskey’s The Applied Theory of Price (available free of charge in its entirety on the author’s website!):
If people are aware of their own ignorance – the first stage of true wisdom – then they will not buy any secondhand car, knowing that it must be a lemon. The exchange will simply not happen, one way of avoiding a bad exchange. Or dealers who can determine whether a car is a lemon will spring up, guaranteeing the car (at a price). Or knowledge that one is buying a lemon if one buys from Sam’s Fly-by-Night Auto Sales will become widespread, and the price of the cars that do not end up on Sam’s lot will fall closer to their true value. Perfect knowledge is not necessary for exchange to be mutually beneficial, only knowledge that one is not perfectly knowledgeable. [emphasis mine]
Critics often claim that economists underestimate human being’s cognitive limits. Reflect, then, on how undemanding McCloskey’s final assumption is. You don’t have to be Albert Einstein or John von Neumann to acquire the “knowledge that one is not perfectly knowledgeable.” In fact, the less you resemble Einstein and von Neumann, the more obvious your fallibility ought to be. Just pay attention to the world for five minutes, and this knowledge is yours.