The Impact of Feedback under Information Asymmetry on Market Dynamics: Results from a Classroom Experiment

Abstract

This paper focuses on the problem of so-called "lemon markets", first described by George Akerlof, where information asymmetry about product quality leads to dysfunctional outcomes such as poor average product quality and relatively low levels of trade, resulting in a loss of collective wellbeing. In the age of online commerce, the problem is especially relevant, given that consumers buy many more products without relying on personal experience than at any time in the past. Possible solutions to the problem suggested in the literature are reputation building on the part of producers and improving the information available to consumers, e.g., by way of publicly accessible consumer reviews (even though these can be gamed or faked by sellers). The paper presents the results from a classroom experiment that simulated a "lemon market". The advantage of using a classroom experiment is that while the market is recreated along a small number of rules and incentives, in line with neat economic models, the participants are real, living decisionmakers, displaying the deviations of actual human behaviour from that of a hypothetical "rational actor". In all, 294 students majoring in business information technology participated, making up 11 simulated markets. The results presented focus mainly on the supply side, namely, the quantities and prices of goods offered, and nine supply curves are estimated (for three quality grades of goods in three phases of the game). The research concludes that under perfect information, the market performs efficiently. In the condition where only sellers but not buyers have information about product quality, the volume of trade declines, although not as drastically as previous findings have suggested, and the market shows signs of recovery, albeit at a suboptimal equilibrium. After the option of consumer feedback is introduced, the market shows further convergence toward the socially optimal state. The results reaffirm that consumer feedback plays an important role in filling the information gap when product quality is uncertain; however, it is not sufficient in itself to overcome the "lemon market" problem. Other important influences on consumer behaviour under uncertainty are suggested, such as risk-taking, changing attitudes towards the act of (online) purchases, and cultural factors.