Asymmetric Info (Market Failure)

What make a perfect market:

  1. Consumers have perfect info
  2. Consumers are rational
  3. Utility is maximized

It’s better for producers to give perfect information to consumers because it takes away fears (from consumers) of the unknown. 

Adverse Selection (Type of Asymmetric Info)

When one of the parties has better information and USES IT TO THEIR ADVANTAGE. 

  • This can be either buyer or seller.
    • Buyer example: The buyer knows your health better when purchasing health insurance.
    • Seller has better info when selling a used car.
  • The selection does not maximize COMMUNITY surplus because of the information difference.
  • The problem occurs before the the transaction is completed.
Solutions to Adverse Selection

  • Screening: \n

    • The party with less information tries to get more information
    • Eg: Insurance companies requiring health questionnaires

  • Signaling:

    • The party with more information shares more info about the product with the other party
    • Eg: An job applicant provides examples of previous work or previous performance reviews 

  • Government measures:

    • Government will do things to make sure that people do these things
    • Disclosure laws: Govt. lawfully requiring people to share certain information.
    • Eg: Packaged foods have nutritional value and ingredients because govt. makes them
      • This reduces asymmetric information.
    • Warranty requirements

  • Quality and safety standards:

    • Eg: Safety or quality of towns and cities is shared so people can make the right decision

  • Licensure of professions

Moral Hazard

When one party has an incentive to take risks because someone else gets to deal with negative consequences.

  • Eg: It’s snowing and someone wants to go out, usually they might not, but since they have insurance they’ll go out because insurance will pay for their car anyways
Solutions to Moral Hazard
  • Regulation
  • Deductibles

Asymmetric information can be useful sometimes like with surgery (you want your surgeon to know more than you) or wit education (you’d want your teacher to know more than you) but you don’t want it to be abused.