3.2.2 - Imperfect Information Flashcards
What is the distinguishing behind wrong decisions and irrational decisions?
Wrong decisions are a result of spending money on a good, expecting to get utility from it, but actually not getting any/little utility from it.
Irrational decisions are spending money on an item that you know at the time you will get no utility from.
Why may people choose to underspend a merit good, and overcosume a demerit good?
They may not possess sufficient information in order to prevent them making a wrong decision.
What is asymmetric information?
One party to a market transaction possesses less relevant information to the exchange than the other.
How can asymmetric information manifest itself?
Through adverse selection.
What is adverse selection?
Adverse selection is when one economic agent has more information than another economic agent, so one economic agent can make a wrong decision as a result.
Who described the problem of asymmetric information in an article?
George Akerlof.
What did Akerlof’s article describe?
The market for ‘lemons’
‘lemons’ is slang for poor quality second hand cars.
What did Akerlof’s article entale?
Suppose there are only 4 types of cars. New and used. Good and bad.
A new car may be good or bad. A used car may be good or bad.
The individuals within the market buy a new car without knowing whether or not the car they purchase will be good or bad.
There is clearly an asymmetry of information here, as the sellers have far more information about the cars they are selling, and the buyers do not know.
This leads to all good and bad used cars selling at the same price however, as if there is one used car that is priced lower than another, it is clear to a consumer that is a lemon, therefore it is less likely to sell.
If the car is priced at the same point, then it will sell at the same price despite its lower quality.
