2. Imperfect information

Asymetric information

When either the buyer or seller has more information

Consequences of imperfect information

Under consumption of merit goods

Over consumption of demerit goods

Merit goods

Goods that are considered to be beneficial to individuals and society as a whole but are often under consumed

Demerit goods

A good whose consumption is considered harmful to the consumer and society but often over consumed in a free market

imperfect information

when an economic agent lacks information necessary to make a rational decision due to informaion being incomplete, missing or inaccurate.

why is information importaint

essential for making rational economic decisions as without it one cannot properly evaluate costs and benefits

example of imperfect information

addiction to drugs + alcohol →

smoking considered to be healthy in the early 20th century - inacurate

uncertinaty on quality of second hand products - asymetric

risks from vaping - missing

examples of asymetric information

buyer has more info → health/car insurance, financial markets (creditworthiness, mortgages)

seller has more info → used vehicles, housing market, doctors

which economict wrote The market for lemons

George Akerlof

Explain the makert for lemons theory

market for used cars

some cars are poor quality/lemons and others are high quality

sellers know more about the quality of cars

buyers can’t accurately acertain the quailty of a car

the buyer will only be willing to pay a low price as they dont know if they are getting a lemon or high quality car

sellers are unwilling to supply high quality vehicles as they are being undervauled by buyers

the average quality of cars available falls

buyers are no longer willing to pay average prices

risk of complete market failure

however buyers would have been willing to buy the high quality cars at higher prices if there was perfect info → efficiency lost

solutions to the market for lemons problem

regulating transparecy

waranties eg 1 year guarantee

how is the market for lemons problem applicable in health insurence

Young people who have no health problems are less likely to get health insurance

people with health conditions more likely to get health insurance

buyers may conceal health issues

moral hazard buyers may take excessive risk as they know they are protected from the negative consequences of their actions

insurers have to charge a higher average price to account for the risk

insurance premiums rise and low-risk people are further less likely to

How asymetric information can affect markets

asymetric info → Buyers cannot determine a products quality and sellers of higher quality goods may be reluctant to participate as it is difficult to demonstrate the quality of their goods → discourages buyers and sellers from participating in the market → buyers are less willing to pay a higher price. When imperfect information is severe markets may become extremely thin as few buyers and sellers attempt to communicate enough info so that they can agree on a price

how technology affects information failures

large amounts of information available → limited time to process → imperfect info

new comparison websites → compute large amounts of information for economic agents → help to complete information

personalised adverts + search suggestions → adds bais → imperfect info

fake news → inaccurate information

how can imperfect information lead to market failure

over/under consuption of ceritan goods due to differences in acual vs percieved utility → partical market failure

asymetric information → market for lemons → complete market failure

moral hazard

when one party chooses to make risky descions becasue the costs of those risks are incurred by another party should the risks lead to large losses over profits.

how does asymetric information contribute to moral hazard

Asymmetric information leads to risky behaviour by the informed party. This occurs because the party with less information cannot accurately assess the risks involved.