1.3.4 Information Gaps

Question 1

Information failure

Answer 1

occurs when people have inaccurate or incomplete data and so make potentially ‘wrong’ choices/decisions.
- Information failures are ubiquitous, most people make decisions in the market without full information of the costs.

Question 2

Competitive markets information assumption

Answer 2

In competitive markets, it is assumed there is perfect information (ie consumers/producers have full knowledge about prices, benefits and costs of g/s available)

Question 3

Difference between imperfect and asymmetric information

Answer 3

imperfect information is lacking crucial information to make rational decisions. Asymmetric information is one party having more information than the other.

Question 4

Example of information failure:

Answer 4

Our food content and sugar content. This could be a factor behind growing levels of obesity. In Saudi Arabia, 69.4% of the population is obese.

Question 5

Causes of information failure

Answer 5

• Long-term consequences
• Complexity
• Unbalance (asymmetric) knowledge
• Price information

Question 6

Information gaps and merit goods graph:

Question 7

Causes of information failure (long-term consequences)

Answer 7

• information gaps about long term benefits of costs of consuming a product
• e.g regarding education, in South Korea it is a social norm to consume education compared to other countries who might be more likely to drop out

Question 8

Causes of information failure (complexity)

Answer 8

• information failure when a product is highly complex
• E.g understanding the best pension product to buy

Question 9

Causes of information failure (asymmetric)

Answer 9

i.e when the buyer knows more than the seller, or the seller knows more than the buyer (this can distort choices)

Question 10

Causes of information failure (price information)

Answer 10

when consumers are unable to quickly/cheaply find sufficient information on the best prices for different products

Question 11

Asymmetric information in markets

Answer 11

1) Landlords
2) Mortgages
3) Car insurance
4) education
5) Healthcare
6) Car seller

Question 12

Asymmetric information in markets (landlords)

Answer 12

Landlords who know more about their properties than tenants

Question 13

Asymmetric information in markets (mortgages)

Answer 13

A borrower knows more about their ability to repay a loan than the lender, insufficient checks might be made

Question 14

Asymmetric information in markets (car insurance)

Answer 14

Car insurance companies cannot tell the risks associated with selling premiums to each single driver- they have to pool risks

Question 15

Asymmetric information in markets (education)

Answer 15

Some students have superior knowledge about how to get into the elite/best universities including which prior courses to take

Question 16

Moral hazard

Answer 16

• (an example of asymmetric information) when the party with superior information alters his/her behaviour in such a way that benefits himself while imposing costs on those inferior information (highlight principal-agent problem)
• occurs when insured consumers are likely to te greater risks, knowing that a claim will be paid for by their cover

Question 17

Moral hazard example

Answer 17

1. Bail-outs of the banking system after the 2007 crash
2. Dentists and patients face the problem of moral hazard (because of supplier-induced demand)

Question 18

Asymmetric information (market failure in health insurance) graph

Question 19

Adverse selection

Answer 19

• health insurance: those most likely to purchase health insurance are those who are most likely to use it (e/g smokers, drinkers, those with underlying long-term health issues)
• The health insurance company knows this and so raises the average price of insurance cover
• This prices some healthy lower-risk consumers out of the market, meaning that mainly higher risk individuals gain insurance- this causes market failure

Question 20

Group health insurance as a solution to adverse selection

Answer 20

if an employer purchased insurance for the whole company. The insurer doesn’t have to worry about adverse selection since the employer doesn’t know much more about the health of their workers. Health insurance is provided regardless of their health.

Question 21

Fixing adverse selection problem example

Answer 21

• Affordable care act (Obamacare)
• Everyone is supposed to buy health insurance, forcing the healthy people into the pool of those who buy insurance which will moderate the cost of health insurance

Question 22

Complexity- bounded rationality

Answer 22

idea that the cognitive, decision-making capacity of humans cannot be fully rational in part because of the complexity of information involved

Question 23

Examples of imperfect information

Answer 23

• over-consumption of tobacco/ alcohol
• under-consumption of healthcare or Education

Question 24

Information gap diagram

Answer 24

• individuals have imperfect information about their own private benefits (over estimating the benefits)
• If they have better/full information the demand curve would be lower therefore less willing to buy the good

Question 25

Consequences of information gaps

Answer 25

market failure

Question 26

Example of asymmetric information

Answer 26

second-hand cars

Question 27

Asymmetric information (George Akerlof)

Answer 27

a Nobel Prize-winning economist who first outlined the problem of asymmetric information

Question 28

Ways information failure can be reduced

Answer 28

• Labels: Compulsory labeling on products (cigarettes)
• info: Improved nutritional information (labeling systems) on foods and drinks
• ads: Hard-hitting anti-speeding advertising to reduce the number of road accidents
• Campaigns to raise awareness of the risks of drink-driving/drug abuse
• Campaigns on dangers of gambling addiction
• Performance league tables for schools
• Consumer protection laws e.g right for refunds of faulty goods
• Industry standards/ guarantees for selling used products such as second hand cars
• Group health insurance as a solution to adverse selection

Question 29

How information failure of the private and external costs can lead to market failure (example 1)?

Answer 29

• some students who continue to take smart drugs despite a poor understanding of their long-term health risks. Consumers might be making ill-informed choices by under-estimating their own internal costs in the long term from the search for a quick fix.

Question 30

How information failure of the private and external costs can lead to market failure (example 2)?

Answer 30

An important investigation here from David Shukman at the BBC reporting on findings that some brands of bottled water contain plastic particles. Part of the wider debate over the externalities of plastic pollution and information gaps among consumers about the private and external costs from consumption,

Question 31

The theory of lemons

Answer 31

The lemon theory posits that in the used car market, the seller has more information regarding the true value of the vehicle than the buyer. This results in the buyer not wanting to pay more than the average price of the car, even if it is of premium quality.

Question 32

Asymmetric information (healthcare)

Answer 32

• consumers have more information about their health status than insurers
• Insurers have to price the coverage based on the average cost among consumers.
• However, a proportion of the most healthy people might decide that the cost of the insurance > the expected benefits so won’t buy it
• so the average cost of those who will buy will increase.
• Then the same dynamic occur (relatively healthy people won’t find it worth paying the price)
• Expected costs and price will increase again. This continues until firm finds that there is no price at which it can attract (with healthcare costs lower than the price of insurance = market failure

Question 33

Asymmetric information (healthcare) evaluation

Answer 33

• people who are healthier and follow a healthy lifestyle (as well as those who smoke) to avoid risk might also buy insurance to avoid risk.
• This assumes that everyone calculates costs and benefits the same way.
• People have differential tolerances for risk (see propitious selection)
• This keeps costs low and doesn’t lead to market failure
• This can also be prevented by checkups so insurers can get a better idea of the consumers expected healthcare costs (charge health consumers less, sicker ones more)

Question 34

Asymmetric information (healthcare) evaluation of evaluation

Answer 34

• However, consumers might feel this is unfair since the sick have to pay more. It might also reveal too much information therefore rendering health insurance no longer viable.
• E.g if a test reveals a consumer has cancer, the price of the policy might be around the cost of treating cancer which is no longer insurance, but a bill (benefits of insurance is lost)

Question 35

Propitious selection

Answer 35

where the people who buy the health insurance are healthier. there are risk-avoiding personalities who both take physical precautions and buy financial security

Question 36

Asymmetric information (car market)

Answer 36

• George Akerlof
• Cars come in a variety of conditions. The sellers know more about the car quality than the consumers
• Since consumers don’t know the quality, they won’t be willing to pay more than what an average quality car is worth.
• Since the consumers are only willing to pay for average quality, car sellers with higher selling cars will exit the market.
• so the quality of car will fall = consumer surplus decreases (death spiral)

Question 37

Adverse selection (George Akerlof)

Answer 37

• In the Theory of Lemons, Akerlof suggested that this could lead to adverse selection due to the incentive to sell bad quality cars (lemons) and hold back the good cars with the equilibrium price is lower than real value of their good car.

Question 38

Ways to overcome the overconsumption of state healthcare

Answer 38

• In Australia ppl above a certain income have to get private healthcare
• Ireland only free healthcare up to age of 7