HL 2.10 Market Failure Asymmetric information

What is asymmetric information

Where buyes and sellers do not have equal access to infromations

- When one side of the party has more information than the other side

What happens in an asymmetric information

Usually results in an under allocation of resources to the production of the good

Foundation of economics (consequences)

People have perfect information → BUT this is not true

- Adverse selection

- Moral hazard

Adverse selection

Decisions made when one party knows less than the other = not always optimal

eg. a used car dealer may now more about the cars than the buyer, the buyer unknowingly choose a bad deal

Moral hazard

When one party knows more than the other, they take advantage of that

eg. if a car is insured, you may be more likely to take a larger risk when driving

Responses to asymmetric information

- Government responses

-Private responses

Government responses

- legislation + regulation: pass laws to make transactions more transpaent

eg. force firms to keep advertisements honest

- private responses:

1. Signalling: reassure buyers that what they are buying are legitimate

2. Screening: try to find out more information about the other party in the transaction