Quacks, Lemons, and Licensing: A Theory of Minimum Quality Standards

I consider markets with asymmetric information. As suggested by Akerlof, quality deterioration in such markets may take place. I show that this is a general phenomenon. Minimum quality constraints (or “licensing requirements”) are examined as a possible solution to the problem. Although not generally a first-best solution, such constraints will increase welfare in a number of cases. The types of markets that are likely to benefit from minimum quality standards are identified. It is then shown that, if quality standards are set by the profession (or industry) itself, it is likely that the standards will be too high.

Hayne E. Leland

Journal of Political Economy

December 1979

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