Imperfect information

Question 1

Rational behaviour assumes full information

Answer 1

1. People use all the information available to them
2. People try to maximise total satisfaction
3. People make independent choices
4. Consumers have stable, consistent preferences

Question 2

How essential is information?

Answer 2

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

Question 3

Examples of imperfect information

Answer 3

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

Question 4

Information gaps

Answer 4

When people have inaccurate, incomplete, uncertain or misunderstood data

Question 5

Asymmetric information

Answer 5

A situation in which one party in a transaction has more or better information than the other

Question 6

Situations where the seller knows more than the buyer?

Answer 6

Pharmacy prescription advice
Used vehicles(2nd hand cars)
Private tutoring/universities

Question 7

In which situations might the buyer know more than the seller?

Answer 7

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

Question 8

Extra examples of asummetric information

Answer 8

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

Question 9

Warranty

Answer 9

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)

Question 10

Buying a product on credit-

Answer 10

Taking a product now, then paying for it later

Question 11

Imperfect information: Over-estimating benefits

Answer 11

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 12

Imperfect information: Under-estimating cost

Answer 12

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

Question 13

George Akerlof - market for lemons

Answer 13

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

Question 14

George Akerlof and economics of information-

Answer 14

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

Question 15

Overcoming the Lemons’ problem:

Answer 15

1. Offer extended test drives for potential buyers
2. Require a full service history including MOT test logs(so a vehicle has no defects)
3. Extended car warranties to lower risk of purchase
4. Mandatory “cooling off” period after purchase such as 7-14 days to avoid “buyer remorse”(can get money back by returning products)
5. Extensive pre-purchase diagnostic testing(to ensure no fault on vehicles) of vehicles’ reliability by the dealer using skilled mechanics
6. Social media - Customer review platforms to help improve trust between buyers and sellers

Question 16

Scanners

Answer 16

How shops know a product belongs to them

Question 17

Interventions to improve information

Answer 17

1. Health warnings
2. Nutritional labelling
3. Gamble aware
4. Industry standards
5. Consumer protection laws
6. Compulsion/Changing the default(forcing you to do something e.g. vaccination)

Question 18

Examples of consumer protection laws

Answer 18

Trading standards are laws that protect consumers

Question 19

Significance of information gaps/failures

Answer 19

1. Information failure is inevitable in a world of complexity
2. Paradox of choice
3. Heuristics
4. Fake news and misleading advertising - damage consumer sovereignty, lead to a loss of allocative efficiency
5. Information failure - impacts equity(students from poorer backgrounds finding it hard to access the best universities/apprenticeships)
6. Behavioural interventions can make a difference, but “hard” nudges may be needed e.g. compulsory vaccinations

Question 20

Paradox of choice

Answer 20

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

Question 21

Bounded rationality

Answer 21

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

Question 22

Heuristics

Answer 22

Mental shortcuts that we use to make decisions quickly and efficiently - they help us make decisions without having to consider all the information available

Question 23

Anchoring heuristics

Answer 23

When we rely heavily on the first piece of information, we receive to decide

Question 24

Examples of heuristics used in decision-making

Answer 24

1. Price-quality heuristic
2. Familiarity heuristics
3. Brand loyalty heuristics
4. Availability heuristics

Question 25

Price-quality heuristic

Answer 25

Many consumers choose more expensive/higher-price products, believing it will offer superior performance or durability

Question 26

Familiarity heuristics

Answer 26

Consumers often choose brands or products they’re familiar with, because they feel a sense of comfort and trust

Question 27

Brand loyalty heuristics

Answer 27

Many consumers stick with a brand for years, if their preferred brand consistently delivers quality and satisfaction

Question 28

Availability heuristic

Answer 28

When consumers recall instances of a product or brand readily, they are more likely to choose it.