Airbnb and the Asymmetry of Information

Devon Zuegel (@devonzuegel on Twitter, and definitely worth following) was less than happy with Airbnb recently:

And so of course I thought about Akerlof (1970)

This paper relates quality and uncertainty. The existence of goods of many grades poses interesting and important problems for
the theory of markets.

Akerlof, G. (1970). The Market for “Lemons”: Quality Uncertainty and the Market Mechanism. The Quarterly Journal of Economics, 84(3), 488-500

It’s a paper that every undergraduate student ought to read. Not just economics undergraduate student, mind you, but every undergraduate student. Because it helps you get an understanding of many modern businesses today.

But first, a relatively simple explanation of the core idea of the paper:

Suppose buyers cannot distinguish between a high-quality car (a “peach”) and a “lemon”. Then they are only willing to pay a fixed price for a car that averages the value of a “peach” and “lemon” together (pavg). But sellers know whether they hold a peach or a lemon. Given the fixed price at which buyers will buy, sellers will sell only when they hold “lemons” (since plemon < pavg) and they will leave the market when they hold “peaches” (since ppeach > pavg). Eventually, as enough sellers of “peaches” leave the market, the average willingness-to-pay of buyers will decrease (since the average quality of cars on the market decreased), leading to even more sellers of high-quality cars to leave the market through a positive feedback loop.

Thus the uninformed buyer’s price creates an adverse selection problem that drives the high-quality cars from the market. Adverse selection is a market mechanism that can lead to a market collapse.

Akerlof’s paper shows how prices can determine the quality of goods traded on the market. Low prices drive away sellers of high-quality goods, leaving only lemons behind. In 2001, Akerlof, along with Michael Spence, and Joseph Stiglitz, jointly received the Nobel Memorial Prize in Economic Sciences, for their research on issues related to asymmetric information.

https://en.wikipedia.org/wiki/The_Market_for_Lemons#

Now, one way to understand the value of many businesses today is to realize that they’re solving asymmetry of information problems. Or at least, that’s how I think of it when I end up looking up the rating for a restaurant on Zomato in a unfamiliar part of town. I don’t know enough about this part of town, and I certainly don’t know this restaurant. Should I walk in for a meal or not?

I could always check if the people already inside are smiling or not, of course, but let’s face it, most of us will simply Zomato our way through this problem. Zomato is reducing the asymmetry of information problem. Successfully or not is a matter of opinion and perhaps controversy. But my argument here is that this is a potentially useful way of thinking about the problem: how to decide where to eat?

How to decide whom to recruit? Linkedin.

How to decide whom to trust? Look ’em up on Facebook, or Twitter, or Instagram, or wherever it is that people look up people these days.

How to decide which product to buy on Amazon? Check out the user ratings. In fact, sort by average user ratings! Yes, Amazon does provide this option.

How to decide which book to read? Goodreads.

How to… you get the drift, right. Part of the reason these firms are so highly valued by the public is because they solve the asymmetry of information problem.

And so does Airbnb. Or does it?

And that brings us back to Devon Zuegel’s tweet.

Every review left on Airbnb informs potential users about the quality of a stay at a particular host’s place. The more information they are able to glean from reviews left by previous users, the more they are likely to definitively transact…or not. That is, potential users will either stay at a particular place, or will definitely not.

Since Airbnb gets a cut from each transaction, but not from each no-stay, they have an incentive to put up only positive reviews. And that is the problem that we have to think about when we read Devon Zuegel’s tweets. Is Airbnb incentivized to leave only positive reviews up? Short answer: yes. Therefore, will they leave only positive reviews up? I’d say it’s a question of horizons, but it is also a question of the calculus.

Airbnb will not last for very long if they pull down every single negative review, because that will destroy trust.

But:

  • every now and then…
  • particularly for really highly rated hosts…
  • especially during a pandemic…
  • will the odd negative review…
  • have a higher chance of being pulled down?

Nothing in life is ever black and white, and the truth lies somewhere in the middle. So no, Airbnb will not pull down every single negative review, but we also shouldn’t assume that it will leave every single negative review up.

More information in the hands of the consumer is a wonderful thing, and it does reduce the asymmetry of information. But who is providing the information to the consumers, and what are their incentives? What if the providers of the good/service are the ones that are making information available to the eventual consumers? Will that need to be regulated, and if so, how?

Zomato, LinkedIn, Uber, Airbnb – it’s a great time to be alive, because these firms, and many others like them, have provided for many services that would simply have not been possible otherwise. They have successfully reduced the asymmetry of information problem. But it’s not the end of the asymmetry of information problem, not just yet.

If anything, it just got more interesting.