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Quality, Uncertainty and the Internet: The Market for Cyber Lemons

The internet makes it easier for buyers to purchase goods from distant sellers. However, the inability of the buyer to examine the merchandise results in asymmetry of information. This paper develops a theoretical model to analyze the relationship between quality and price in a setting of asymmetrical information. In the spirit of Akerlof (1970), the model predicts that higher quality goods are less likely to be sold in the market. Since buyers have difficulty distinguishing quality, sellers would have to accept lower prices for their highest quality items. The model is tested using data from internet coin auctions. The results show that coins that are claimed to be of higher quality are less likely to sell and when they do sell do so at lower prices relative to their market value.