1.3.4 Information Gaps Flashcards
Information failure
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.
Competitive markets information assumption
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)
Difference between imperfect and asymmetric information
imperfect information is lacking crucial information to make rational decisions. Asymmetric information is one party having more information than the other.
Example of information failure:
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.
Causes of information failure
- Long-term consequences
- Complexity
- Unbalance (asymmetric) knowledge
- Price information
Information gaps and merit goods graph:
Causes of information failure (long-term consequences)
- 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
Causes of information failure (complexity)
- information failure when a product is highly complex
- E.g understanding the best pension product to buy
Causes of information failure (asymmetric)
i.e when the buyer knows more than the seller, or the seller knows more than the buyer (this can distort choices)
Causes of information failure (price information)
when consumers are unable to quickly/cheaply find sufficient information on the best prices for different products
Asymmetric information in markets
1) Landlords
2) Mortgages
3) Car insurance
4) education
5) Healthcare
6) Car seller
Asymmetric information in markets (landlords)
Landlords who know more about their properties than tenants
Asymmetric information in markets (mortgages)
A borrower knows more about their ability to repay a loan than the lender, insufficient checks might be made
Asymmetric information in markets (car insurance)
Car insurance companies cannot tell the risks associated with selling premiums to each single driver- they have to pool risks
Asymmetric information in markets (education)
Some students have superior knowledge about how to get into the elite/best universities including which prior courses to take
Moral hazard
- (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
Moral hazard example
- Bail-outs of the banking system after the 2007 crash
- Dentists and patients face the problem of moral hazard (because of supplier-induced demand)
Asymmetric information (market failure in health insurance) graph
Adverse selection
- 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
Group health insurance as a solution to adverse selection
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.
Fixing adverse selection problem example
- 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
Complexity- bounded rationality
idea that the cognitive, decision-making capacity of humans cannot be fully rational in part because of the complexity of information involved
Examples of imperfect information
- over-consumption of tobacco/ alcohol
- under-consumption of healthcare or Education
Information gap diagram
- 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