Asymmetric grading error and adverse selection: Lemons in the California prune industry

Grading systems are often introduced to address the classic adverse selecti on problem associated with asymmetric information about product quality. Ho wever, grades are rarely measured perfectly, and adverse selection outcomes may persist due to grading error. We study the effects of errors in gradin g, focusing on asymmetric grading errors-namely when low-quality product ca n erroneously be classified as high quality, but not vice versa. In a conce ptual model, we show the effects of asymmetric grading errors on returns to producers. Application to the California prune industry shows that grading errors reduce incentives to produce more valuable, larger prunes.