Living Economics

A leaky Dodge Caravan made by Chrysler was passed on through three unsuspecting buyers in three different states without knowing that the car was a lemon. Lemon laws in most states that do have such laws usually require that lemons repurchased by auto makers revealed their lemon status. But since such disclosure requirements and enforcement differ from state to state, lemons are frequently laundered across states without full disclosure of their lemon status.

Lemons do not all come from poorly made cars. After Hurricane Katrina, flood-damaged vehicles turned up in Florida, Arizona, New York, Oklahoma, and California without “salvage” on the title that has been “washed” in states with weaker title laws. Because salt water corrodes metal parts, gums up joints and damages electrical and computer systems, these salvage lemons will move through the system ruining the lives of many unsuspecting buyers.

The widespread practice of lemon laundering reflects the human reluctance to accept capital loss. The lemon laws in some states mandate a refund if the product is in fact defective. But what happens to the returned lemons? Under perfect information, lemons would be resold at a lower price as lemons or written off as scraps. Without perfect information, lemons are passed off as quality items to unsuspecting buyers in order to avoid a capital loss.

So a whole industry to help buyers and sellers evaluate product quality has emerged. In turn, the problem of judging the quality of information brokers arises. The sad fact is that those least able to bear the loss tend to be stuck with lemons in the system. They are too poor to pay for advice and too uneducated to get the needed information on their own.

The problem of imperfect information is more serious for big-budget infrequently purchased capital goods. For frequently purchased low-budget items, mistakes are inexpensive ways to learn how to improve one’s future purchase decisions. Ironically, low-budget items are usually sold with money-back guarantee. But it is the big-budget items that are most in need of and do not carry money-back guarantees.