Demand and supply determine the price of a used car and the quantity traded, but the market doesn’t work well. To explain, we’ll focus on an extreme outcome in which only lemons get traded.

Suppose that buyers have learned from their friends that everyone who has bought a used car got a lemon. They assume that they, too, will get a lemon. Consequently, the demand for used cars is based on the willingness to pay for a lemon. The market demand is the demand for