4.1.2.2 Imperfect information

Question 1

What two factors cause imperfect information?

Answer 1

Lack of information, asymmetric infomation

Question 2

What will do happen to the consumption of merit goods due to imperfect information?

Answer 2

They will be under consumed

Question 3

What will do happen to the consumption of de merit goods due to imperfect information?

Answer 3

They will be over consumed

Question 4

What sort of decision making can happen from imperfect information?

Answer 4

Irrational decision making

Question 5

Asymmetric Information

Answer 5

when one party involved in a transaction has more or superior information than another party

Question 6

Information failure

Answer 6

an undesired result due to the situation where one party of a deal has more accurate and different information than the other party

Question 7

What does asymmetric information lead to ?

Answer 7

• This will lead to market failure.
• This leads to a misallocation of resources. Consumers might pay too much or too little, and firms might produce the incorrect amount.
• For example, monopolies might exploit the consumer by charging them more than they need to.

Question 8

Adverse selection

Answer 8

Adverse selection occurs when there is asymmetric (unequal) information between buyers and sellers.

Question 9

Example of adverse selection - insurance

Answer 9

A company selling life insurance will find that people at higher risk of death will be much more willing to want to buy life insurance. If the insurance company charges an average price, but only high-risk consumers buy – they will make a loss.
If a company selling life insurance sells at a high price to take account of the high-risk people, then young, healthy people will not buy. Because the cost is greater than their perceived value.

Question 10

Consequences of adverse selection

Answer 10

Due to poor information and difficulty selecting customers, there will be a higher overall price as firms have to take into account relatively higher payouts to high-risk customers taking out insurance.

Low-risk customers may not want to buy because it istoo expensive for their needs – leading to a missing market.

Question 11

Solutions to adverse selection

Answer 11

To avoid adverse selection, firms need to try and identify different groups of people. This is why there are health insurance premiums for people who smoke and obese people.

Insurance firms will charge different rates to consumers depending on factors, such as

Age
Postcode.

Question 12

What can help the consumers in this situation (of asymmetric information) - Policy options?

Answer 12

• consumer protection
• rights (e.g. labelling ingredients)
• ‘cooling-off’ period
• provide a warranty
• use of internet price comparison websites