The Effects of Information Asymmetry
The Effects of Information Asymmetry
Information asymmetry is a universal phenomenon in the trading market. The seller often knows more about the product’s quality than the buyer. In the labour market, the job applicant knows much more about how qualified they are than the potential employer. People who buy insurance often have a much better understanding of their risks than the insurance company which is selling them insurance. These kinds of cases lead to several kinds of problems. These problems “emerge in such markets when the information held by the two parties to the trade is not symmetric”. Relevant issues like adverse selection (hidden information) and moral hazard (hidden action) will be discussed, make examples in the sections below. On the other hand, why do insurance companies offer different insurance contracts to different policy-holders? Why do customers go to several shops only to compare the price of the same goods? Why do employers take the educational level as a significant factor when they choose a job applicant? What they do above are measures to mitigate the problems as the result of asymmetrical information. Specifically, some of these measures are called signaling and screening which will be discussed below with some examples.
Let us take the ideal market as a starter. Under the circumstances of an ideal market, we can have perfect competition. In this case, we have three main assumptions. One of those assumptions is that there are massive amounts of buyers and sellers. All of these economic entities have minimal effect on the aggregate supply and aggregate demand of the whole market. They have to accept the established price, and therefore they are called “price-takers”. The second assumption is the goods are exactly alike. Not only the quality, specification and trademark are all the same, but also it includes shopping environment, after-sale service, etc. We can buy any product from any seller without concern for the quality of the
Information asymmetry is a universal phenomenon in the trading market. The seller often knows more about the product’s quality than the buyer. In the labour market, the job applicant knows much more about how qualified they are than the potential employer. People who buy insurance often have a much better understanding of their risks than the insurance company which is selling them insurance. These kinds of cases lead to several kinds of problems. These problems “emerge in such markets when the information held by the two parties to the trade is not symmetric”. Relevant issues like adverse selection (hidden information) and moral hazard (hidden action) will be discussed, make examples in the sections below. On the other hand, why do insurance companies offer different insurance contracts to different policy-holders? Why do customers go to several shops only to compare the price of the same goods? Why do employers take the educational level as a significant factor when they choose a job applicant? What they do above are measures to mitigate the problems as the result of asymmetrical information. Specifically, some of these measures are called signaling and screening which will be discussed below with some examples.
Let us take the ideal market as a starter. Under the circumstances of an ideal market, we can have perfect competition. In this case, we have three main assumptions. One of those assumptions is that there are massive amounts of buyers and sellers. All of these economic entities have minimal effect on the aggregate supply and aggregate demand of the whole market. They have to accept the established price, and therefore they are called “price-takers”. The second assumption is the goods are exactly alike. Not only the quality, specification and trademark are all the same, but also it includes shopping environment, after-sale service, etc. We can buy any product from any seller without concern for the quality of the
References: Estrin, Saul & David Laidler ‘ The Economics of Information’, Chapter 26 in Introduction to Microeconomics, 1999, Harvest Wheatsheaf. Lofgren, Persson and Weibull 2002. ‘Markets with Asymmetric Information: The contributions of George Akerlof, Michael Spence and Joseph Stiglitz’. Scandanavian Journal of Economics, 104(2), 195-211 Economic Approaches to Organisations (2002) 3nd edition, Sytse Douma and Hein Schreuder. Prentice Hall. Chapter 4 Intermediate Microeconomics (2003), John D. Hey. Mcgraw Hill Higher Education. Chapter 34 Asymmetric Information, Corporate Finance, and Investment (1990), R. Glenn Hubbard, University of Chicago Press. P1-14 -------------------------------------------- [ 1 ]. Estrin, Saul & David Laidler ‘ The Economics of Information’, Chapter 26 in Introduction to Microeconomics, 1999, Harvest Wheatsheaf. [ 2 ]. Lofgren, Persson and Weibull 2002. ‘Markets with Asymmetric Information: The contributions of George Akerlof, Michael Spence and Joseph Stiglitz’. Scandanavian Journal of Economics, 104(2), P207 [ 3 ]. Estrin, Saul & David Laidler ‘ The Economics of Information’, Chapter 26 in Introduction to Microeconomics, 1999, Harvest Wheatsheaf.