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Manabu Hirohata Head Agent
Avoid Buying a Lemon
Why do LEMONs appear on the market?
George Akerlof, receiver of the 2001 Nobel Prize in Economics, explained the reason why lemons
(inferior used-cars) appear on the used-car market. We would like to illustrate
how to avoid purchasing these lemons through using his story.
Economics sound like a difficult topic but this is a very easy story to understand .....
"Mr. Wanted Peach" was looking for a great vehicle.
There was a man who wanted to buy a used-car. His name was "Mr. Wanted Peach."
He wanted a used-car where the exterior, interior, and engine were in great condition.
Of course, he wanted to avoid buying a vehicle with hidden problems.
There were two used-car dealers in the town.
These two dealers both appeared to be the same in every way.
But in fact, ...
EARNEST AUTO SERVICE .....
Mr. Earnest was a fair and honest man.
All vehicles sold by by him were usually in top condition.
Moreover, he was happy to sell these vehicles for only a slight profit.
His long-established company was loved by the people of the town.
LEMON AUTO SERVICE .....
Across the street, there was a newly-established car dealer.
Mr. Lemon increased their business by offering cheaply priced used-cars.
Their vehicles appeared perfectly fine.
But there was a secret to their cheap prices.
All of their vehicles had some hidden problems.
Now they are offering a BENZ which looks like a twin of EARNEST AUTO's BENZ
... the same model, the same year, the same color, the same mileage.
Mr. Wanted Peach went to the dealers.
Both of the dealers were constantly smiling and friendly,
and both of the BENZs were shiny. Mr. Peach could not see any difference between the two vehicles.
Mr. Wanted Peach then recalled what his friend had said to him.
His friend :
"One-third of used-cars are lemons. So you have to carefully choose a dealer.
Buy your vehicle from a HONEST dealer.
Don't buy one from a SLEAZY dealer."
But the trouble was that he had no idea who was a good, knowledgeable, HONEST man
or a sloppy SLEAZY scammer!
"One-third of used-cars are lemons ...
I was going to buy a used-car which is in great condition for 9,000USD
but I have a one-third chance of buying a lemon. So I will pay about two-thirds of my budget,
maybe up to 6,000USD (9,000USD x 2/3 = 6,000USD)."
What will become of Mr. Peach's negotiation?
At EARNEST AUTO SERVICE .....
Mr. Earnest :
"Hi, can I help you find something?
Mr. Peach :
"Sure. I would like to buy the BENZ. How much is it?"
Mr. Earnest :
"It is 9,000USD. That is a real bargain!!!"
Mr. Peach :
"It is so expensive. ... Okay, let's make it 6,000USD.
What do you say?"
Mr. Earnest :
"Oh, no. We couldn't let the car go for 6,000USD.
That's really a bit too low. We couldn't accept such an offer since
this BENZ is in great conditin and will go for 8,000USD EVEN at a dealer auction!"
Mr. Peach :
"Oh, Okay ... I see. I'm sorry, but I don't want this car."
The negotiation between Mr. Peach and EARNEST AUTO SERVICE broke down.
At LEMON AUTO SERVICE .....
Mr. Lemon :
"May I help you, sir?
Mr. Peach :
"I would like to buy the BENZ. How much is it?"
Mr. Lemon :
"You must have a sharp eye, choosing a car of such high quality.
It is also at the bargain price of 7,000USD.
Mr. Peach :
"Oh. Maybe I should look somewhere else. My budget amount is 6,000USD."
Mr. Lemon :
"Come back, sir! Wait a minute, wait a minute, wait a minute ...
Ummmm 6,000USD ... What a smart shopper you are!
Well, well, we will be in the red but we accept your price.
YOU WIN! And we will make it 6,000USD. LUCKY YOU!"
Finaly, Mr. Peach bought the defective car from LEMON AUTO SERVICE at 6,000USD.
What will EARNEST AUTO SERVICE do with his lost sale?
At EARNEST AUTO SERVICE .....
Then Mr. Earnest heard an industry rumor --
Recently, 6,000USD used-cars had become very popular in the market ...
Mr. Earnest :
"I see. Customers want more reasonably priced used-cars!"
So Mr. Earnest searched and purchased top condition vehicles that he could offer at 6,000USD.
Of course, he maintained the vehicles very carefully and offered the vehicles for only a very slight profit.
Mr. Wanted Apple appeared.
Around that time, there was another man who wanted to buy a used-car.
His name was "Mr. Wanted Apple." He was looking for a great vehicle for around 6,000USD.
So he visited Earnest Auto Service and Lemon Auto Service .....
---- (had the same experience as Mr. Peach) -----
and the result was .....
Mr. Apple purchased a defective used-car from LEMON AUTO SERVICE at a price of 4,000USD.
What will EARNEST AUTO SERVICE do with another lost sale?
At EARNEST AUTO SERVICE ..... again
Mr. Earnest :
"Why does this keep happening?
We are working very hard and are offering great vehicles but no one buys any vehicles from us.
We can't go on this way.
What shall I do?"
Then Mr. Earnest heard a different industry rumor --
Recently, 4,000USD used-cars had become very popular in the market ...
----- (and the past repeated itself over and over again) -----
After all .....
Mr. Earnest thought that there was nothing else they could do
and EARNEST AUTO SERVICE began offering defective used-cars (LEMON USED-CARs).
The Point of This Story
1)
There are good dealers and bad dealers in the used-car business.
2)
Buyers want to buy a used-car from a good dealer.
But buyers are unable to know who is a good dealer before they buy.
3)
Buyers cannot help but reduce their budget amount with this trading uncertainty.
4)
Buyers only sign a contract with dealers who offer low-priced vehicles,
so it is usually the bad dealers that thrive in business, and the good dealers that dwindle in business.
This market mechanism is called Adverse Selection because only the bad dealers survive
and thrive in the market, which goes against good common sense.
In this mechanism, all buyers and all good dealers suffer a loss,
but only the bad dealers make a profit.
The problem's main cause is the difference in information between the dealers and buyers.
Dealers have far more information about the history and reliability of their vehicles than the buyers do.
Buyers are unable to make informed decisions so they cannot help but reduce their budget amount
lower than the price each of them is willing to pay for their ideal vehicles.
Buyer's Loss (Mr. Apple's Loss):
When a buyer purchases a vehicle without knowing its hidden problems,
a lemon used-car can cost the buyer thousands of dollars over what the vehicle is actually worth.
After purchasing, the vehicle can also cost thousands of dollars in costly repairs in the near future.
Good Dealer's Loss (Mr. Earnest's Loss):
When buyers make comparisons, a good dealer's vehicle looks very expensive
even though a good dealer offers a top condition vehicle at the low-end price of what it is worth.
So buyers will not choose to buy the good dealer's vehicle and the good dealer's business slows down.
Bad Dealer's Profit (Mr. Lemon's Profit):
When buyers make comparisons, a bad dealer's vehicle looks like a great bargain,
which is contrary to the actual facts, so a bad dealer receives a lot of inquiries about their vehicles.
In this way, the bad dealer's business increases.
Solution:
Since the problem's main cause is the information difference between the dealers and the buyers,
the solution is for you to have every bit of information that the dealer has.
By purchasing through
Auto House Auction Agent Services ...
...
you can know your target vehicle's
true condition through an auction sheet,
i.e. vehicle's condition report by a professional inspector.
(If Mr. Peach had a chance to review the auction sheet before he made his purchase,
he would have known the vehicle's hidden problems, i.e. its major accident history and odometer tampering,
and avoided purchasing the lemon BENZ.)
you can know your target vehicle's
fair price through the latest auction results,
i.e. dealer's wholesale prices.
(If Mr. Peach had known the dealer auction's wholesale prices before he made his purchase,
he would have realized the 6,000USD selling price was too low to purchase such a great vehicle
and that there must be some hidden problems with the lemon BENZ.)
