From Lemons to Refurbs
Decoding the Economics of Smartphone Choices
“Half the price, nearly the same quality, super eco-friendly”. If you ever find yourself torn between the decision of buying a new vs second-hand phone, headlines like these will definitely entice you towards the latter. After all, beyond the short-lived excitement of making the ‘unboxing my brand new iPhone’ video, saving some bucks certainly seems like the most rational decision. In fact, in 2023, “one-quarter of those who bought a device chose a refurbished or second-hand model rather than a new one”. But are you really getting the most out of your hard-earned money? Or is someone else benefiting far more than you are? Let’s dive deeper into the economic brains of all the agents involved in this transaction and (hopefully) find an answer!
The Lemons
You thought we were gonna talk about Apple(s)? Well, in the second-hand market, you’ll only find Lemons. Even before you enter a shop, you’ll already be aware of the fact that the person behind the till has far more information about the device that they are selling than you ever could. Of course, unless you have some form of supernatural powers to read other people’s minds, the information that you and the seller have will never be the same, or so to speak- symmetrical. Economists call this concept ‘Asymmetric Information’. Quite straightforward, right?
What we are saying is that you would never be able to tell the difference between a high-quality phone (a peach) which is worth £500 vs a low-quality one (a lemon) worth £300. So what does your rational brain do when it realises that you have a 50-50 chance of getting either of the two? It calculates the expected value of the phone, which in this case is: 0.5 ✕ £500+0.5 ✕ £300=£400 . Hence if you pay anything more than £400, you’d be making a bad choice.
The result: every economist’s nightmare - MARKET FAILURE.
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But what is that and how does it cause an entire market to fail?
Hold on, let us explain:
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We’ve already established that, in this case, the maximum you’ll be willing to pay for a used phone is £400.
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On the other hand, the seller will only sell their phone if the price you pay them is at least equal to or, ideally, higher than what the true value of their device. In this case £300 and £500 for low vs high quality sellers, respectively.
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Now put yourself in the shoes of the high-quality seller, receiving £400 for something you know is worth £500, what would you do?
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Of course, you’d rather keep your beloved digital companion to yourself instead of selling it short!
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And not just you, all sellers in the market possessing a high-quality phone will end up making the same decision.
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Eventually, there will be no high-quality phones left on the market. The low-quality phones will have inevitably driven them out of the market. This is exactly how asymmetric information leads to Adverse Selection - a form of market failure resulting from equal pricing of products with different quality, which causes a misallocation of resources, reduced market participation and overall loss of welfare. In this case, a trade that could have benefitted both you, if you prefer a high-quality phone, and the seller of peaches fails to occur.
The Lemons Problem developed by the economist Akerlof G.(1970) is something that will follow you on every alley and street of the second-hand market.
A New Hazard...
Now suppose you’re selling a high-quality phone. How can you convince the buyer that they’re not going to end up with a lemon? You offer them insurance: a free return policy. It was found that “1 out of 10 smartphones are returned” (Choney, 2012). The question is why? Well, it turns out that retailers who promote insurance on their goods are subject to being victims of a notorious economic concept: Moral Hazard!
Yes, Market Failure Again
Let’s admit it, at the end of the day we all want to maximise our utility and minimise our risks. So obviously we will take advantage of others where possible. For example, as buyers, we could exploit lenient return policies and engage in what is known as “Fraudulent Return Behaviour” (Chang, 2021) by purchasing items for short-term use and returning them soon after. Although such policies can enhance consumer satisfaction, they can also create opportunities for abuse. This behaviour undermines the integrity of the return process and imposes costs on retailers. Moral Hazard in return policies, especially within the second-hand market, is one to look out for. Something that both retailers and consumers must carefully navigate through.
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Another Option
When looking for a cost-effective and environmentally friendly alternative to buying the latest iPhone, you have two options: purchasing a second-hand item or opting for a refurbished phone. Buying second-hand technology can be a gamble, as these phones may not be fully tested or repaired. However, a seller who values their reputation will avoid selling faulty products as there would be the opportunity cost to never sell any more products from the bad reputation they would gain. Carefully selecting the seller would give you a better chance of a great product. Opting for the refurbished phones might cost you more, but they are restored to their original condition, making them just like brand-new ones. Also, they typically come with a warranty, so if you happen to receive a faulty product, you should be able to get it replaced.
Every good thing has an ending... So does this Blog
​​As you already understand, the second-hand market can be a bit tricky. But now you know the problem is asymmetric information, leading to the 'Lemons Problem' and market failure. As well as returns and moral hazard further complicating choices. But there’s microeconomics behind it all and looking from the opposite side, now you can choose your new (or should I say old?) device wisely!
References
Akerlof, G. (1970). “The Market for “Lemons”: Quality Uncertainty and the Market Mechanism”, Quarterly Journal of Economics, 84(3): 488-500 (Accessed: 18 April 2024).
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Chang, H.-H. (2021) Consumer rights or unethical behaviors: Exploring the impacts of retailer return policies. Available at: https://www.sciencedirect.com/science/article/pii/S0969698921003453 (Accessed: 18 April 2024).
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Choney, S. (2012) 1 in 10 smartphones returned, says study, NBCNews.com. Available at: https://www.nbcnews.com/tech/tech-news/1-10-smartphones-returned-says-study-flna6191172 (Accessed: 18 April 2024).
Che, Y.-K. (1996). Customer Return Policies for Experience Goods. The Journal of Industrial Economics, 44(1), p.17. doi:https://doi.org/10.2307/2950557 (Accessed: 18 April 2024).
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Csatadi K. (2022). “​​Buying refurbished and second hand tech”. Ethical Consumer.https://www.ethicalconsumer.org/technology/buying-second-hand-tech
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Gibbs S. (2021). How to buy a secondhand smartphone – and what to look out for. The Guardian.https://www.theguardian.com/money/2021/aug/21/how-to-buy-a-secondhand-smartphone-and-what-to-look-out-for?CMP=share_btn_url
GFK (2024). One-quarter of all mobile phones sold in the UK in 2023 were bought secondhand or refurbished. [online] Available at: https://www.gfk.com/press/one-quarter-of-all-mobile-phones-sold-in-the-uk-in-2023-were-bought-secondhand-or-refurbished .