Imperfect information Flashcards
Rational behaviour assumes full information
- People use all the information available to them
- People try to maximise total satisfaction
- People make independent choices
- Consumers have stable, consistent preferences
How essential is information?
Information is essential for making sound economic decisions- without information, it’s impossible to properly evaluate costs and benefits or make informed choices.
With imperfect information, market failure can occur
Examples of imperfect information
Addiction to painkillers and other drugs
Gaining entry to top degree courses
Cowboy builders or other “rip-off merchants”- these builders claim to know what they’re doing, but they don’t
Information gaps
When people have inaccurate, incomplete, uncertain or misunderstood data
Asymmetric information
A situation in which one party in a transaction has more or better information than the other
Situations where the seller knows more than the buyer?
Pharmacy prescription advice
Used vehicles(2nd hand cars)
Private tutoring/universities
In which situations might the buyer know more than the seller?
Market for health insurance(risk of adverse selection effects- people selling health insurance ask consumers personal questions beforehand)
Market for secured and unsecured loans(“creditworthiness”
Antique experts(insider)- trained buyers know how much antiques are worth
Extra examples of asummetric information
Mortgages: A borrower knows more about their ability to repay a loan than the lender
Information advantages for high-frequency stock market traders
Landlords who know more about their properties than tenants
Product warranties
Warranty
Form of insurance e.g.Payment Protection Insurance(needed if you buy something you have to pay for later, as losing your job could stop you paying for the product you’ve bought on credit)
Buying a product on credit-
Taking a product now, then paying for it later
Imperfect information: Over-estimating benefits
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
Imperfect information: Under-estimating cost
Individuals may have imperfect information about their own private costs - for example, the impact of consumption decisions on their health and wellbeing in the long term
George Akerlof - market for lemons
A market where buyers and sellers have different levels of information about the quality of the product being sold. In this market, buyers are wary of being “taken for a ride” and end up paying less for the product than it’s worth
George Akerlof and economics of information-
Sellers know more about quality of used vehicles than buyers:
Buyers cannot tell accurately the quality of cars available for sale:
Buys will therefore offer an average price for all cars:
This is typically lower than the sellers’ perceived value(especially for good cars):
Some sellers will remove their “good” vehicles from open sale:
The average quality of cars therefore falls:
Buyers no longer willing to buy at average prices - this increases risk of the market disappearing
Overcoming the Lemons’ problem:
- Offer extended test drives for potential buyers
- Require a full service history including MOT test logs(so a vehicle has no defects)
- Extended car warranties to lower risk of purchase
- Mandatory “cooling off” period after purchase such as 7-14 days to avoid “buyer remorse”(can get money back by returning products)
- Extensive pre-purchase diagnostic testing(to ensure no fault on vehicles) of vehicles’ reliability by the dealer using skilled mechanics
- Social media - Customer review platforms to help improve trust between buyers and sellers
Scanners
How shops know a product belongs to them
Interventions to improve information
- Health warnings
- Nutritional labelling
- Gamble aware
- Industry standards
- Consumer protection laws
- Compulsion/Changing the default(forcing you to do something e.g. vaccination)
Examples of consumer protection laws
Trading standards are laws that protect consumers
Significance of information gaps/failures
- Information failure is inevitable in a world of complexity
- Paradox of choice
- Heuristics
- Fake news and misleading advertising - damage consumer sovereignty, lead to a loss of allocative efficiency
- Information failure - impacts equity(students from poorer backgrounds finding it hard to access the best universities/apprenticeships)
- Behavioural interventions can make a difference, but “hard” nudges may be needed e.g. compulsory vaccinations
Paradox of choice
Choice overload can distort our decisions- most people have bounded rationality(don’t have time to collect all the information to make a rational decision)/bounded self-control
Bounded rationality
This concept was pioneered by Nobel laureate Herbert Simon:
Bounded rationality is the idea humans have limited cognitive resources and are unable to make completely rational decisions.
They must make decisions based on the information they have available, and when there are information gaps, it can lead to sub-optimal choices.
In such cases, they must rely on heuristics or rules of thumb to simplify complex decision-making processes.
Bounded rationality also takes account the cost of acquiring and processing information
Heuristics
Mental shortcuts that we use to make decisions quickly and efficiently - they help us make decisions without having to consider all the information available
Anchoring heuristics
When we rely heavily on the first piece of information, we receive to decide
Examples of heuristics used in decision-making
- Price-quality heuristic
- Familiarity heuristics
- Brand loyalty heuristics
- Availability heuristics
Price-quality heuristic
Many consumers choose more expensive/higher-price products, believing it will offer superior performance or durability
Familiarity heuristics
Consumers often choose brands or products they’re familiar with, because they feel a sense of comfort and trust
Brand loyalty heuristics
Many consumers stick with a brand for years, if their preferred brand consistently delivers quality and satisfaction
Availability heuristic
When consumers recall instances of a product or brand readily, they are more likely to choose it.
