Information asymmetry: concept, ways to eliminate, consequences for the economy

2024 Author: Henry Conors | [email protected]. Last modified: 2024-02-12 02:53

Information asymmetry affects decisions in transactions where one party is more informed than the other. It creates an imbalance of power that can lead to transactional errors or market failure in the worst case. Examples of this problem are adverse selection, knowledge monopoly, and moral hazard.

Concept

Information asymmetry occurs when one side of an economic transaction has more material knowledge than the other. This usually occurs when the seller of a product or service has more knowledge than the buyer, although the opposite is also possible. Almost all economic transactions involve information asymmetry.

Disaggregation of information

Information asymmetry is the specialization and division of knowledge in society in relation to economic trade. For example, physicians tend to know more about medical practice than their patients. After all, due to extensive education and training, doctors specialize in medicine, while most patients do not. Thisthe same principle applies to architects, educators, police officers, lawyers, engineers, fitness instructors, and other specially trained professionals.

Models

Models of information asymmetry and its manifestations suggest that at least one participant in the transaction has the relevant information, while the other does not. Some of them can also be used in situations where at least one party can enforce certain parts of the agreement or take effective retaliation for breaches of them, while the other party cannot.

In adverse selection models, the ignorant party has no information when negotiating a deal agreement. In the case of moral hazard, she is not aware of the implementation of the agreed deal or has no opportunity to avenge the breach of the agreement.

Economic benefits

The consequences of information asymmetry for the economy can be not only negative, but also favorable. Its growth is a desirable outcome of a market economy. When employees specialize and become more productive in their areas, they can provide more value to employees in other areas. For example, the services of a stock broker are more valuable to clients who do not know enough to buy or sell their own shares with confidence.

One alternative to the ever-expanding information asymmetry iseducating workers in all areas rather than specializing where they can provide the most value. Although there may be higher costs associated with this and possibly lower total output, resulting in a lower standard of living.

Another alternative is to make large amounts of information available and inexpensive, such as through the Internet. It is important to note that this does not replace information asymmetry. This only leads to its displacement from simpler areas to more complex ones.

Flaws

In certain circumstances, information asymmetries can lead to adverse selection and moral hazard. These are situations where individual economic decisions are hypothetically worse than they would be if all parties had more symmetrical information. In most cases, the problem of moral hazard and adverse selection is fairly easy to deal with. The news agency can help with this.

Consider an adverse choice using life insurance or fire insurance as an example. High-risk customers such as smokers, the elderly, or people living in dry areas may be more likely to purchase insurance. This could raise premiums for all customers, forcing others to forego insurance. The solution is to do actuarial work and insurance screening and then charge various premiums to clients based on the potential risks associated with them.

Finance

Information asymmetries tend to be greatest in areas where information is complex, difficult to access, or both. For example, it is relatively difficult to obtain exclusive information when trading in antiques, but fairly easy in areas such as law, medicine, technology, or finance.

Financial markets often rely on reputational mechanisms to prevent financial professionals from abusing clients. The financial advisors and fund companies that turn out to be the most honest and efficient asset managers tend to get clients. Dishonest or inefficient agents lose customers or face legal damages.

Adverse selection

According to economic theory, information asymmetries are most problematic when they lead to adverse market selection. Theoretically, it leads to a sub-optimal market, even when both sides of the exchange behave rationally. This sub-optimality gives entrepreneurs an incentive to take risks and contribute to better outcomes.

Market reaction

There are several broad methods for dealing with adverse selection problems. One is the solution for manufacturers to provide warranties and returns. This is especially noticeable in the used car market.

Another intuitive and natural response for consumers and competitors is to act inas monitors for each other. Consumer reports, insurer labs, notary publics, an overview of online services, and news agencies will help fill in the information gaps.

The study of efficient market mechanisms is known as design theory, which is a more flexible offshoot of game theory. Its authors are Leonid Gurvich and David Friedman.

Alarm

One way to eliminate information asymmetry is signaling. This idea was originally voiced by Michael Spence. He suggested that people signal their situation by believably conveying information to the other side and removing asymmetries. This idea has been explored in the context of labor market selection. The employer is interested in hiring a new employee who is "experienced in training". Of course, all future employees will claim that they are qualified in training, but only they know if this is true. This is information asymmetry.

Spence suggests, for example, that going to college is a reliable signal of learning ability. After graduating from college, qualified people signal their skill to potential employers. However, graduating from college may simply be a signal that they are able to pay for tuition, a signal that people are ready to adhere to orthodox views or submit to authority.

Screening

The screening theory was pioneered by Joseph Stiglitz. It lies in the fact thatan insufficiently informed party may induce the other party to reveal its information. Parties may provide a selection menu in such a way that it will depend on the private information of the other party.

There are numerous examples of situations where the seller usually has more complete information than the buyer. They include used car dealers, mortgage brokers and lenders, stock brokers and real estate agents.

Examples of situations where the buyer usually has better information than the seller include selling real estate, life insurance, or selling antiques without prior professional valuation. This situation was first described by J. Kenneth Arrow in the Public He alth Article in 1963.

George Akerlof in his scientific work "The Market for Lemons" notices that the average cost of a product tends to decrease even for those who have excellent quality products. Due to information asymmetry, unscrupulous sellers can fake goods and deceive the buyer. As a result, many people are not willing to take risks.

State

In the 20th century, interest in the problems of improper economic development was largely due to the problems of the formation of the world economy. The role of the state in minimizing information asymmetry is great and global. It is as follows:

• single navigation system via the Internet;
• information resources provided by the state that contain informationon all activities of federal government agencies with mandatory access to private organizations and citizens;
• infrastructure of points with public access to information about any activity of all federal government bodies;
• system of registration and registration of citizens with the provision of information, the possibility of requests and control over their execution;
• publication and timely distribution system.

Creating a single information space is one of the main tasks of the state, capable of coping with this role.