imperfect-information

Asymmetric Information

• One of the assumptions of free markets is that there is a perfect flow of information

  • This would include information on pricing, the availability of substitutes, the truthfulness of the product claims, etc

• Information gaps exist in nearly all free markets and distort market outcomes, resulting in market failure

  • Perfect information in the market means that buyers and sellers have exactly the same level of information about the good or service. This is called symmetric information

  • In many markets, buyers and sellers have different levels of information. This is called asymmetric information. For example, there is asymmetric information in the used car market: sellers know more about the vehicle than the buyers

•  Asymmetric information distorts socially optimal prices and quantities in markets, resulting in over or under-provision of goods or services

  • For example, goods/services with dangerous side effects would be sold in lower quantities if buyers were aware of these effects (consider the VW emissions scandal). Fewer factors of production should be allocated towards producing these

  • Similarly, goods and services with extra benefits would be sold in higher quantities if buyers were aware of them. More factors of production should be allocated towards producing these