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Life lessons from used cars

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Life lessons from used cars 2
Wednesday, 27 April 2022
easynomics
A newsletter that demystifies complex economic jargon and explains how it impacts your everyday life
Life lessons from used cars 3
By Vivek Kaul

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Life lessons from used cars

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One of my guilty pleasures is watching some mindless television while having lunch. The Big Bang Theory is what I turn to usually, rewatching the episodes multiple times.

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A few days back, while watching the sitcom, I came across a terrific song that played in the background in the sixth episode of the second season.

The song titled, Be My Yoko Ono has been sung by the Canadian band the Barenaked Ladies. The same band has also sung the title song of the sitcom.

This particular episode titled “The Cooper–Nowitzki Theorem” revolves around Sheldon Cooper, one of the lead characters of the series, and a new female student, Ramona Nowitzki. Those who have watched the series know that Sheldon is a genius, having been a child prodigy. Ramona is obsessed with Sheldon’s genius and ultimately starts controlling his daily routine.

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In this context, the creators of the series thought of playing Be My Yoko Ono in the background, as a montage of scenes showing Ramona taking over Sheldon’s daily life plays out.

The lyrics of the song go like this.

You can be my Yoko Ono

You can follow me wherever I go

Be my, be my, be my, be my Yoko Ono, whoa, oh.

Dear reader, if you are wondering where this is going, allow me to explain.

I loved how The Big Bang Theory creators used an immensely hummable song to establish Ramona’s obsession with Sheldon, like Yoko Ono’s obsession with John Lennon.

For millennials and zoomers, John Lennon was a part of The Beatles, unquestionably the greatest rock band of all time. Yoko Ono was his second wife. He was her third husband.

The fact that the creators (of The Big Bang Theory) were able to make the connection between the montage of scenes in that episode with the song left me very impressed. It also made me think about economics and how the best thinking and writing on the subject is largely about making non-obvious connections, especially in a world that is throwing data and information at us all the time.

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Let’s take the case of the Indian Premier League (IPL) T20 tournament. Multiple reports suggest that the IPL TV ratings have dropped this year. Different reasons have been offered for it, from cricket overdose to students writing exams. But then, these reasons do not impact the faithful like us. We are to IPL what many women (and men) are to soap operas. Irrespective of whether the storyline is moving forward, they keep watching them religiously.

In fact, Waseem Barelvi, the greatest Urdu poet alive, even has a couplet on this phenomenon.

Ghar Me Ek Sham Bhi Jeene Ka Bahana Naa Mile,

Serial Khatm Na Ho Jaye To Khana Na Mile.

Of course, given that I make my dinner, I don’t have anyone else to blame if I keep watching IPL and my dinner gets late.

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While the cricket keeps playing in the background with the sound on mute, what interests me are the advertisements that get broadcast between overs and during the very ad-friendly strategic timeouts, which happen four times a match (which explains why football with just one break in between is such an advertiser-unfriendly sport).

Every year, the kind of advertisements broadcast on IPL tell you which companies are flush with money. Like last year, crypto platforms and apps which allow you to invest in stocks and mutual funds carried out a lot of advertising.

However, this year, the crypto platform wallahs have gone missing. Their place has been taken up by companies inviting you to make cricket teams digitally, play rummy (a card game) and make money, and finally, buy and sell used cars with ease. Among these, the business of used cars has caught my fancy. In fact, the entire economics of trying to sell or buy a second-hand car teaches us life lessons.

So, this is me making a connection, linking economic theory with everyday life. Read on.

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The market for lemons.

Basu Chatterjee’s Choti Si Baat is perhaps one of the best comedies ever made in Hindi cinema (right up there with Hrishikesh Mukherjee’s Chupke Chupke). It starred Amol Palekar, playing a character named Arun, who has to compete with another character named Nagesh, played brilliantly by Govardhan Asrani, for the attention of a woman named Prabha, played by the late Vidya Sinha.

The problem is that Nagesh has a scooter and Arun doesn’t (zoomers please remember that the story was set in the 1970s). So, Arun goes to buy a two-wheeler from a local garage. Unfortunately, the garage sells him a dud, a motorcycle which barely runs.

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From this example, right out of 1970s Hindi cinema, we can learn important lessons in economics. In fact, the economist George Akerlof was awarded a Nobel Prize for his work in this area.

In 1970, at a very young age of 30, Akerlof published a research paper titled The Market for Lemons. In this paper, he started with problems that arise while buying or selling a used car (like Arun trying to buy a second-hand motorcycle). In this paper, Akerlof called the used car market a market for lemons. In American English, a car with defects is referred to as a lemon.

In the paper, Akerlof wrote: “There are new cars and used cars. There are good cars and bad cars. A new car may be a good car or a lemon, and of course, the same is true of used cars.” The point being made is simple. When Arun in Choti Si Baat went to buy a motorcycle from a local garage, he had no idea about its quality, given that he was a first-time buyer and not really an expert on motorcycles. The garage owner knew the quality of the bike. He also knew that Arun did not know. He used Arun’s lack of knowledge to sell him a lemon.

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This lack of knowledge leads to information asymmetry, where the seller of the vehicle knows about its quality (or the lack of it), but the buyer doesn’t. While Arun may have been a rookie and a naïve buyer, many other buyers aren’t. They know that they don’t have any idea about the quality of the vehicle. Nonetheless, they tend to incorporate this realization into the price they offer for the vehicle, assuming that all second-hand vehicles are likely to be lemons, simply because if they weren’t, why are they being sold in the first place.

The information asymmetry that prevails leads to the second-hand vehicles market not operating efficiently.

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The lemons and good cars sell at the same price. As Akerlof wrote: “The bad cars sell at the same price as good cars since a buyer can’t tell the difference between a good and a bad car; only the seller knows.”

In fact, this leads to a situation where the only second-hand vehicles being sold are lemons. As Tim Harford writes in The Undercover Economist: “The market doesn’t work nearly as well as it should; second-hand cards tend to be cheap and of poor quality. Sellers with good cars want to hold out for a good price, but because they cannot prove that a good car is really a peach, they cannot get that price and prefer to keep the car for themselves. You might expect that the sellers would benefit from inside information, but in fact, there are no winners: smart buyers simply don’t show up to play a rigged game.”

Several entrepreneurs have figured out an opportunity in this scenario and started companies to tap in. The companies have placed themselves between the sellers and the buyers. The sellers can sell their vehicles to these companies and get paid based on the quality of the vehicle. The companies have hired people to establish this trust. After having bought the vehicle, they can sell it to prospective buyers. Of course, unlike neighbourhood garages, the companies have a reputation to maintain to ensure that they get repeat business from positive word-of-mouth referrals.

In that sense, the companies selling used vehicles essentially want to solve the information asymmetry problem.

Don’t quit your job without getting a new one

If you are tired of your job or just looking for a new challenge, one cliched advice that everyone gives you is to get a new job and only then quit the current one. While this suggestion may sound like a cliché, it makes tremendous sense simply because the information asymmetry that prevails can create a problem.

Let’s say, fed up with your boss, you quit your job in the heat of the moment. You also think that your resume and skills are good enough to get hired by another company. Maybe your estimation of your skills is correct, but you really don’t know what a prospective employer is thinking.

If you think about it, the problem is similar to trying to sell or buy a used vehicle. You are a seller of the skills you have.

The prospective employer is the buyer. You know the reason why you have quit your job. You don’t like your boss or are looking for a bigger challenge, intellectual or otherwise.

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The prospective employer does not know the reason you have quit your job. Of course, the employer can ask you the right questions during the interview and try and figure them out. Nonetheless, the information asymmetry that prevails creates doubts. The prospective employer might want to know why you quit your job? Also, did you quit your job or were you fired? And if you did quit your job without getting a new one, are you too much of a rebel? Most of the time, people who can’t do what they are told don’t fit well into organizations, especially large ones (tell me about it!).

As Ray Fisman and Tim Sullivan write in The Inner Lives of Markets: “If a job applicant’s previous employer didn’t want to keep him on the payroll, it’s worth asking why not. You can also imagine that the problem deepens the longer you’ve been out of work: Why on earth hasn’t she found someone willing to give her job, and what are other prospective employers seeing that I don’t.”

There are ways of figuring out all these things, but there’s only so much time and mental bandwidth that prospective employers have.

A journalism story

Here’s this hilarious story that often plays out in journalism. On the editorial side, newspapers and digital media houses have largely got two kinds of people. People who provide content and people who edit it and bring out the publication. Now among people who provide content are reporters, whose primary job is to report and break news. It so turns out that quite a few individuals who are great at getting the news aren’t really great writers.

So, to make their writing readable, people who bring out the publication (or the desk as they are referred to in the profession) rewrite what reporters have written.

In most cases, what the readers read is not what the reporters have written initially but what the desk has rewritten. The readers also include competitors looking to poach good reporters.

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The asymmetry of information that prevails here is that the competitors have very little idea of how good or bad a writer, the reporter they are looking to hire is. In fact, I know of several journalists who aren’t such great writers, who got hired at much higher salaries, only for the competitors who hired them to discover later that they had made a mistake.

This is a situation where information asymmetry leads to an adverse selection and, in turn, hurts the organization that hired the journalist without having much idea about their writing skills. While this did not hurt much when news came out a day later, and there was enough time to rewrite, in this day and age, when news comes out all through the day, writing skills have become much more critical than they were.

Buying a house

And finally, my favourite topic. The residential real estate market in India is plagued with huge information asymmetries. Now let’s consider something as simple as buying a house in a particular area. The first thing as a buyer that you might ask yourself is the going price and at what price homes were recently sold in that area.

Until recently, there was very little publicly available information on this front. You had to trust the broker you had hired. Now, a few websites provide such information, and a few websites also let you buy and sell a home or rent one without hiring a broker. These are good developments, and things can only improve, assuming that venture capitalists keep pumping money into these loss-making ventures.

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People who have not realized the information asymmetries have become victims of adverse selection. Take the example of lakhs of homebuyers who paid money to builders who took the money and disappeared. In fact, every under-construction and to-be-constructed property is a brilliant example of asymmetric information that can lead to an adverse selection.

There is a reason homebuyers should buy fully constructed homes where people already live. First, the chances of a fully-constructed home having all the necessary permissions are higher. Second, the fact that a property is ready means a lot. It doesn’t just have a random completion date that the builder has put out to meet regulatory requirements and can revise at her whim.

Of course, the old adage of caveat emptor doesn’t work here simply because understanding everything that goes into building residential real estate isn’t possible, or even if it’s possible, it’s not feasible for a normal human being. As Jeff Madrick writes in Seven Bad Ideas—How Mainstream Economists Have Damaged America and the World: “Almost all homebuyers…enter into such transactions only two or three times in their lives. How can they possibly be knowledgeable and informed?”

This essentially explains why adverse selection is such a huge problem when it comes to buying homes, and there isn’t much that can be done about it other than purchasing a ready-to-move-in home, even if that means paying more.

To conclude, it is difficult to have all the required information that one may need before one makes a decision. But nonetheless the realization that one doesn’t have all the information required is also a good one and helps in making better decisions. Or as Mark Twain supposedly said: “It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.”

I guess in an era of simplistic LinkedIn lessons and Twitter threads that is the one line takeaway that I can offer from this piece.

PS: Last week, a reader commented that the headline for the piece was clickbait. Yes, it was. What do you expect me to do in an era where my writing competes with everything from Instagram reels to Netflix to WhatsApp forwards? How do I catch your attention, dear reader? I may have written a terrific piece, but if you don’t click on it, you will not read it.

Anyway, the best clickbait headline for today’s piece would have been, What Amol Palekar has in common with Janet Yellen’s husband. If you are wondering why, here’s the answer. George Akerlof, whose theory of lemons we started today’s piece with, is Yellen’s husband. Yellen is the current treasury secretary of the US and was the chair of the US Federal Reserve before that.

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Now that would have been a good clickbait headline. At least, I think so. But the millennial who produces this newsletter doesn’t. I mean, who has heard of Amol Palekar, he says. And Janet Yellen? Next, you will be talking about Janet Jackson. You Boomer!

But, the question is, how does a millennial know about Janet Jackson?

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Written by Vivek Kaul. Edited by Saikat Chatterjee. Produced by Nirmalya Dutta. Send in your feedback to newsletterskatanalivemint.com.

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