By: Sophia Gilbukh, Paul Goldsmith-Pinkham & Michael Sinkinson (ProMarket)
When you go to a used car dealership, you know that the salespeople selling you a car want to make a big commission. Since you don’t buy a car very often, you might worry about being taken advantage of by a salesperson, either by overpaying or buying a car that is not a good match. A common solution would be to bring along someone who is an expert in cars to help you decide which one to buy. You might even pay them back (say, $100) for the time spent picking the best car for you and negotiating the price.
Economists think of the above as a solution to the problem of “asymmetric information”—the salesperson knows more than the potential buyer about the quality and market price of a given used car. By bringing along someone as an advisor, the gap in information between you and the salesperson decreases.
But what if the used car salesperson was the one who is paying your car advisor, and they were paying a fixed 2.5 percent commission of the selling price, conditional on sale? Moreover, the dealership set the commission rate and it was non-negotiable. Would this still seem like a good idea for a car buyer? Your advisor would now have an incentive to make sure you buy a car—any car, since they don’t get paid otherwise—and no incentive to negotiate a lower price…