28 October 2009

Crossroads: Adverse Selection Eliminator

This [unedited] guest post is by a student in my EEP100 class (background post).
Please praise/critique/comment on its economic quality and importance to you.

Korina Cassidy says:

For those of you that don't know, Crossroads Trading Company is a store down on Shattuck that buys used brand name clothes in good condition and resells them at discounted rates from their original prices. Sellers receive 35% of the price that Crossroads will sell the item for. At first glance, this doesn't seem like a good business deal. Why not just find someone on your own to purchase your unwanted clothes and receive all or at least more than 35% of what Crossroads would have made? For one, that would take a lot of your own time to arrange. You must find some way of advertising your clothes, either in a newspaper article or online on websites such as eBay. Once you find a prospective buyer, you must arrange to either meet with them or send them your clothes in exchange for what you hope is a reliable source of payment. This private transaction is risky for both sellers and buyers because they face adverse selection: a situation in which asymmetric information results in high-quality goods or high-quality consumers being squeezed out of transactions because they cannot demonstrate their quality[1]. Basically, sellers with high-quality items will not want to sell them because they are unable to convey their true worth through a description or photo, and will not be able to get the amount of money they deserve. With the creation of paypal and user ratings and feedback, which provide more secure ways of receiving payment, high-quality buyers can be kept in the market and only sellers that make transactions by cash or check in the mail may still face an adverse selection of buyers. Essentially, Crossroads serves as a third party to reduce or eliminate adverse selection. They provide you with the service of finding high-quality clothes, displaying them, and allowing you to browse and buy them at your own convenience. For sellers, they are able to give you reliable payment without the hassle of advertising and finding buyers on your own. Part of the reason sellers only receive a portion of the profit from their items is because of this service. Also, Crossroads must pay for fixed costs such as rent, electricity bills, and clothes racks as well as variable costs such as employees’ wages (considered variable depending on the amount of clothes they have to sell, they may need more or less employees running the store). So while sellers may be able to get more money for their clothes by selling privately and buyers able to bid down prices by buying privately, each can choose to pay a transaction cost to Crossroads to reduce adverse selection and save time.

Even though cheaper brand name clothes may sound great to some, others may argue that it does not help boost the economy, especially in a recession. But Crossroads is an exception in two ways. First, by setting up a store to resell used clothes, it creates employment that wouldn’t have existed otherwise. People would’ve either privately sold their clothes or just held onto them, neither of which creates employment. But by hiring cashiers, people to evaluate and buyback clothes, as well as other higher management positions, Crossroads creates new employment and salaries for those employees to spend on other goods and services. Second, assuming that people buying from Crossroads would've bought new brand name clothes at much higher prices, they now have more money leftover to spend elsewhere. If they can buy a top that would’ve cost $30 for $10.50, they can now spend the leftover $19.50 on something they wouldn’t have bought before. So just because they bought a second-hand item, it does NOT mean that they don’t boost the economy and add to the GDP.

Bottom Line: If you’re short on cash and need a new wardrobe or looking to sell some of your nicer clothes, check out Crossroads. Not all second-hand transactions are bad for the economy, as long as you’re employing a third party in the process or spending your leftover money in other industries.
[1]Case, Karl E., Ray C. Fair, and Sharon M. Oster. Principles of Economics. Upper Saddle River, NJ: Prentice Hall, 2009.

2 comments:

Michelle said...

hmmm...I'm a little disturbed by the underlying feel that the economy is this entity that must be done right by. I like second hand transactions because they reduce waste, reduce resource exploitation, and give a benefit to the buyer and the seller (or the traders in a non-cash transaction). The 'economy' be damned! It's way too big already.
Otherwise, good analysis - I do tend to shop Salvation Army over craigslist to save time on verifying the quality of goods.

Jay said...

I am also disturbed by the post, but for a different reason.

In economics we can study the satisfying of our unique and changing utility functions. (Last week the Knowledge Problem blog used the term hetrogenious utility functions, which I think is a great name for the concept.) Thinking of jobs, money and retail outlets is too narrow a focus for economic thinking.

Individuals all have different wants and needs. Buying designer hand bags may be one persons want while another person might be seeking self actualization (to use Maslow's term - sorry he is not an economist). It's even possible that the same person has these different wants at different times.

Bottom Line: Pay attention to what satifies your individual wants (within the guidelines of civil society). The person urging you to trade in your clunker for cash is probably only satisfying their own desires.