5.5 Information Failure

Question 1

What is information failure in free markets?

Answer 1

Information failure occurs when decisions are made based on ignorance or imperfect information, instead of perfect information assumed in free markets.

Question 2

What are examples of information failure?

Answer 2

Examples of information failure include consumers lacking perfect knowledge of how good or bad a product is for them, effective advertising persuading consumers to consume too much of a product that isn’t very good for them, and packaging misleading or promoting incorrect information to convince consumers to buy products that are not in their best interests.

Question 3

What are the consequences of information failure?

Answer 3

The end result of information failure is consumers making irrational decisions, either under or over consuming, where their total benefit is not being maximized. This causes a misallocation of resources, allocative inefficiency, and market failure.

Question 4

What is asymmetric information?

Answer 4

Asymmetric information occurs when information exists but is not equally shared between two parties, resulting in the consumer or producer lacking the information to make a rational, welfare-maximizing decision.

Question 5

What are examples of asymmetric information?

Answer 5

Examples of asymmetric information include consumers buying second-hand products without having full information over the product’s quality, which is possessed purely by the seller, and mechanics forcing extra payments for repairs that may not be necessary.

Question 6

What are the consequences of asymmetric information?

Answer 6

The consequences of asymmetric information are similar to information failure, where consumers make irrational decisions, leading to a misallocation of resources, allocative inefficiency, and market failure. There are either too few or too many resources being allocated to such markets.

Question 7

Information Failure Diagram (overestimating benefit of good)

Answer 7

• E.g. Overestimating the benefit of food supplements, cosmetic surgery
• This diagram shows effect of Over-estimating the private benefit of consumption
• Individuals may have imperfect information about their own private benefits. If they had better/fuller information on the benefits to themselves of consuming a good or service, the marginal private benefit curve would shift lower leading to a smaller equilibrium quantity

Question 8

Information Failure Diagram (underestimating benefit of good)

Answer 8

• E.g. underestimating the benefit of healthy eating, giving up smoking, education
• Individuals may have imperfect information about their own private benefits. If they had better/fuller information on the benefits to themselves of consuming a good or service, the marginal private benefit curve would shift upwards leading to a greater equilibrium quantity