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

TLDR

Markets with asymmetric information can suffer quality deterioration, as suggested by Akerlof. The study examines minimum quality constraints as a potential solution to quality deterioration in asymmetric information markets. The authors analyze how licensing requirements can mitigate quality decline. The analysis demonstrates that minimum quality standards generally improve welfare in certain markets, identifies which markets benefit, but also shows that self‑set standards tend to be overly stringent.

Abstract

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.