car. He knows that he might buy the car, drive it home, and use it for a few weeks before discovering that car is

a “lemon,” which is slang for a defective product (especially a car).

Imagine that Marvin shops for a used car and finds two that look very similar in terms of mileage, exterior

appearances, and age. One car costs $4,000, while the other car costs $4,600. Which car should Marvin buy?

If Marvin were choosing in a world of perfect information, the answer would be simple: he should buy the

cheaper car. However, Marvin is operating in a world of imperfect information, where the sellers likely know

more about the car’s problems than he does, and have an incentive to hide the information. After all, the more
390 16 • Information, Risk, and Insurance

problems the sellers disclose, the lower the car’s selling price.

What should Marvin do? First, he needs to understand that even with imperfect information, prices still reflect
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