There are many markets in which buyers use some market statistic to judge the quality of prospective purchases. In this case there is incentive for sellers to market poor-quality merchandise, since the returns for good quality accrue mainly to the entire group whose statistic is affected rather than to the individual seller. As a result there tends to be a reduction in the average quality of goods and also in the size of the market. It should also be perceived that in these markets social and private returns differ, and therefore, in some cases, governmental intervention may increase the welfare of all parties. Or private institutions may arise to take advantage of the potential increases in welfare which can accrue to all parties. By nature, however, these institutions are nonatomistic, and therefore concentrations of power – with ill consequences of their own – can develop.

The automobile market is used as a finger exercise to illustrate and develop these thoughts. It should be emphasized that this market is chosen for its concreteness and ease in understanding rather than for its importance or realism.

The model with automobiles as an example

The automobiles market

The example of used cars captures the essence of the problem. From time to time one hears either mention of or surprise at the large price difference between new cars and those which have just left the showroom. The usual lunch table justification for this phenomenon is the pure joy of owning a “lnew” car. We offer a different explanation. Suppose (for the sake of clarity rather than reality) that there are just four kinds of cars.