1.3.4 - Information Gaps

Question 1

Define Symmetric Information

Answer 1

. In a perfect market, buyers and sellers have potential access to the same information

Question 2

Define Imperfect information

Answer 2

. Where buyers or sellers or both LACK information to make an informed decision

. Result in an information gap

Question 3

Define Asymmetric information

Answer 3

. When buyers are sellers have different amounts of information, with one group having more information than the other

. Result in an information gap

. The buyer or seller can easily exploit one another

Question 4

What is an information gap?

When is an information gap seen?

Answer 4

. Between perfect and imperfect information (see diagram). This can be the case with complex information such as washing machines

. Between buyers and sellers when there is asymmetric information

Question 5

Explain Second Hand - cars

Answer 5

. Buyers of second - hand cars don’t know whether the car is good or has defects due to an information gap between the seller and buyer (asymmetric information)

. Buyers will tend to offer a low price for the car and owners will keep the car as they are not offered a good price and eventually stop selling them in the market

. The second hand cards were referred to as ‘lemons’

. This will lead to the underproduction of goods, which is partial market failure

. This same concept can be applied to other goods as well e.g. washing machines, phones, etc.

Question 6

Examples where asymmetric information can lead to the misallocation of resources and market failure

Answer 6

. Pension
. Drugs
. Financial Services
. Second Hand - cars
. Education
. Financial Services (most important)

Question 7

Explain Pension

Answer 7

. Young workers are paying too little into pensions and instead spending money elsewhere.

. This is due to asymmetric information ⁠— many young workers may not be able to imagine what it will be like to life as retired person. As a result, they may ignore the loss of welfare that will come from having a low income at a retired age to instead boost their current spending. This is market failure due to a misallocation of resources. Asymmetric information led to over - consumption at a young ages.

. Governments step in by using compulsory national insurance contributions

Question 8

Explain Drugs and alcohol

Answer 8

. Asymmetric information can lead to an overconsumption of drugs and alcohol, leading to partial market failure

. Individuals may be unaware of the long - term costs of drug and alcohol use

. Manufacturers are far more aware of the risks than most customers

Question 9

Define Moral Hazard

Answer 9

. When an economic agent makes a decision in their own best interest knowing that there are potential risks and if that problem results, the cost will be partly borne on other economic agents as well.

Question 10

Policies for addressing market failure

Answer 10

• Governments can help improve information to consumers and producers so they can value the cost / benefit of a good or service:

. Compulsory labelling of information (e.g. cigarettes and alcohol )

. Industry standards / Guarantees for selling used products (e.g. 30 day guarantee for second - hand cars)

. Campaigns on drug use and alcohol use to ensure symmetric information / perfect information

. Consumer protection laws (e.g. right to return faulty goods)

Question 11

Explain Financial Services

Answer 11

. Financial institutions have more information about products they sell than their costumers

. For example, in the USA bank employees were sell mortgages to low income households leading up to the 2008. The bank employees had the information to know that these households would not repay those mortgages once the low interest mortgage rates expired

. Banks were bundling up their mortgages and selling the mortgages onto third parties as if they were low risk products.

. When it became clear that these households were failing to pay their debt, it led to the 2008 financial crisis. There was information failure and a moral hazard

. The bank employees were paid on how many mortgages they sold not where the mortgages were likely to be repaid, hence why risk mortgages were sold. A collapse of mortgages was a problem for their bank, not them.

Question 12

Explain Education

Answer 12

. In education, the principal is the student and the agents are the parents

. A child suffers from asymmetric information as it does not see the long - term benefits of education. Therefore, students act irrationally by failing to work or not attending school

Question 13

Examples of Principal - agent problem

Answer 13

.Children (principal) and parents (agents)

Question 14

Examples of Principal - agent problem

Answer 14

.Children (principal) and parents (agents)

. Shareholder (principal) and managers (agents)