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Can Consumers Detect Lemons? Information Asymmetry in the Market for Child Care

  • H. Naci Mocan

This paper applies direct tests for adverse selection and moral hazard in the market for child care. A unique data set containing quality measures of various characteristics of child care provided by 746 rooms in 400 centers, as well as the evaluation of the same attributes by 3,490 affiliated consumers (parents) is employed. Comparisons of consumer evaluations of quality to actual quality show that, after adjusting for scale effects, parents are weakly rational. The hypothesis of strong rationality is rejected, indicating that parents do not utilize all available information in forming their assessment of quality. Parent characteristics impact the accuracy of their evaluations. An analysis of easy-to-observe versus difficult-to-observe aspects of quality reveals that parents are trying to extract signals more heavily in cases of difficult-to-observe items. A comparison of parent assessments to results obtained from standard quality production functions reveals that, for the most part, parents interpret the signals incorrectly. The results demonstrate the existence of information asymmetry and adverse selection in the market. There is some limited evidence for moral hazard as nonprofit centers with very clean reception areas tend to produce lower level of quality for unobservable items. These results provide an explanation for low average quality in the child care market.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 8291.

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Date of creation: May 2001
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Publication status: published as Naci Mocan, 2007. "Can consumers detect lemons? An empirical analysis of information asymmetry in the market for child care," Journal of Population Economics, Springer, vol. 20(4), pages 743-780, October.
Handle: RePEc:nbr:nberwo:8291
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  1. Michael P. Keane & David E. Runkle, 1998. "Are Financial Analysts' Forecasts of Corporate Profits Rational?," Journal of Political Economy, University of Chicago Press, vol. 106(4), pages 768-805, August.
  2. H. Naci Mocan, 1995. "Quality Adjusted Cost Functions for Child Care Centers," NBER Working Papers 5040, National Bureau of Economic Research, Inc.
  3. von Ungern-Sternberg, Thomas & von Weizsacker, Carl Christian, 1985. "The Supply of Quality on a Market for "Experience Goods."," Journal of Industrial Economics, Wiley Blackwell, vol. 33(4), pages 531-51, June.
  4. Carl Shapiro, 1986. "Investment, Moral Hazard, and Occupational Licensing," Review of Economic Studies, Oxford University Press, vol. 53(5), pages 843-862.
  5. Mullineaux, Donald J, 1978. "On Testing for Rationality: Another Look at the Livingston Price Expectations Data," Journal of Political Economy, University of Chicago Press, vol. 86(2), pages 329-36, April.
  6. Milgrom, Paul & Roberts, John, 1986. "Price and Advertising Signals of Product Quality," Journal of Political Economy, University of Chicago Press, vol. 94(4), pages 796-821, August.
  7. Robert Heinkel, 1981. "Uncertain Product Quality: The Market for Lemons with an Imperfect Testing Technology," Bell Journal of Economics, The RAND Corporation, vol. 12(2), pages 625-636, Autumn.
  8. Mocan, H. Naci & Azad, Sam, 1995. "Accuracy and rationality of state General Fund Revenue forecasts: Evidence from panel data," International Journal of Forecasting, Elsevier, vol. 11(3), pages 417-427, September.
  9. Genesove, David, 1993. "Adverse Selection in the Wholesale Used Car Market," Journal of Political Economy, University of Chicago Press, vol. 101(4), pages 644-65, August.
  10. H. Naci Mocan, 1997. "Cost Functions, Efficiency, and Quality in Day Care Centers," Journal of Human Resources, University of Wisconsin Press, vol. 32(4), pages 861-891.
  11. David M. Blau, 1997. "The Production of Quality in Child Care Centers," Journal of Human Resources, University of Wisconsin Press, vol. 32(2), pages 354-387.
  12. Feenberg, D.R. & Gentry, W. & Gilroy, D. & Rosen, H.S., 1988. "Testing The Rationality Of State Revenue Forecasts," Papers 16, Princeton, Woodrow Wilson School - Discussion Paper.
  13. George A. Akerlof, 1970. "The Market for "Lemons": Quality Uncertainty and the Market Mechanism," The Quarterly Journal of Economics, Oxford University Press, vol. 84(3), pages 488-500.
  14. Russell Cooper & Thomas W. Ross, 1984. "Prices, Product Qualities and Asymmetric Information: The Competitive Case," Review of Economic Studies, Oxford University Press, vol. 51(2), pages 197-207.
  15. Carl Shapiro, 1982. "Consumer Information, Product Quality, and Seller Reputation," Bell Journal of Economics, The RAND Corporation, vol. 13(1), pages 20-35, Spring.
  16. Bruce C. Greenwald & Robert R. Glasspiegel, 1983. "Adverse Selection in the Market for Slaves: New Orleans, 1830–1860," The Quarterly Journal of Economics, Oxford University Press, vol. 98(3), pages 479-499.
  17. repec:mpr:mprres:1672 is not listed on IDEAS
  18. Thomas N. Hubbard, 1998. "An Empirical Examination of Moral Hazard in the Vehicle Inspection Market," RAND Journal of Economics, The RAND Corporation, vol. 29(2), pages 406-426, Summer.
  19. Asher Wolinsky, 1983. "Prices as Signals of Product Quality," Review of Economic Studies, Oxford University Press, vol. 50(4), pages 647-658.
  20. Leland, Hayne E, 1979. "Quacks, Lemons, and Licensing: A Theory of Minimum Quality Standards," Journal of Political Economy, University of Chicago Press, vol. 87(6), pages 1328-46, December.
  21. Rosenman, Robert E & Wilson, Wesley W, 1991. "Quality Differentials and Prices: Are Cherries Lemons?," Journal of Industrial Economics, Wiley Blackwell, vol. 39(6), pages 649-58, December.
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