The Lemons Problem refers to a market characterized by asymmetric information, where the seller has more knowledge about the quality of the product being sold than the buyer. For example, in the used car market, the sellers have greater knowledge of their car's true quality. While the seller accurately knows the car's history and condition, buyers lack this relevant information about product quality. For instance, a car previously damaged in an accident may have undergone cosmetic repairs to remove visible flaws, such as dents in the fenders and scratches in the paint. This may make the car appear to be high-quality, even though its underlying issues, like engine or suspension damage, persist. This hidden information creates uncertainty for buyers, preventing them from accurately assessing the car's true quality, and hence, its relative market value.

Used cars can be either high-quality "plums" or low-quality "lemons," but their true quality is unobservable to buyers. However, buyers may be aware that consumer studies have shown that 50% of the cars are plums and 50% are lemons. Buyers, therefore, rely on the expected value of any given used car to determine the price they are willing to pay. 

For example, if plums are valued at $20,000 and lemons at $8,000, the expected value is calculated as:

Expected Value = (0.5×$20,000)+(0.5×$8,000)

  = $14,000

This single price of $14,000 is offered by buyers irrespective of whether the car is truly a plum or a lemon. However, this pricing strategy leads to adverse selection. Owners of plums are less motivated to offer their cars for sale at this lower price, and those who do sell their cars cannot receive a price reflecting the true value that their high-quality car represents. Owners of lemons are eager to sell their low-quality cars, and they receive an average sale price that is higher than the underlying value of their cars. A small portion of consumers benefit by receiving a plum and paying a price much less than the value of the car. Most consumers, however, receive a lemon for which they pay a price higher than the underlying value of the car.