The Significance of Asymmetric Information Flashcards
Imperfect information -> Individual economic decision making -> Microeconomics
Key Concepts
What is imperfect information?
Imperfect information occurs when one or both parties in a market transaction lack complete information about the nature of the transaction.
Key Concepts
What is asymmetric information?
Asymmetric information is a situation where one party (buyer or seller) possesses information that the other does not, creating inefficiencies and distortions in market outcomes.
Key Concepts
What is adverse selection?
Adverse selection is a form of market failure caused by asymmetric information, where high-quality goods or buyers exit the market because they cannot distinguish themselves from low-quality counterparts.
Key Concepts
Can you give an example of adverse selection?
An example is the second-hand computer or car market, where buyers cannot tell high-quality goods from low-quality ones.
Key Concepts
What is moral hazard?
Moral hazard occurs when one party takes actions hidden from the other, leading to inefficiency.
Key Concepts
Can you provide an example of moral hazard?
Insured individuals may take greater risks because they bear less cost of their actions.
Akerlof’s “The Market for Lemons”
What did George Akerlof’s 1970 paper address?
It demonstrated the detrimental effects of asymmetric information in markets, focusing on the second-hand car market.
Akerlof’s “The Market for Lemons”
What is the key insight from “The Market for Lemons”?
Buyers assume cars are of average quality due to a lack of information, leading to lower offers. High-quality sellers exit the market, leaving mostly “lemons.”
Akerlof’s “The Market for Lemons”
What are the generalized implications of Akerlof’s work?
Asymmetric information can lead to market collapse and applies to markets beyond cars, including insurance, labor, and financial markets.
Economic Mechanisms and Impacts
How does asymmetric information cause price distortions?
Due to uncertainty, buyers undervalue goods, pushing out high-quality goods or services.
Economic Mechanisms and Impacts
How does asymmetric information lead to market inefficiency?
It reduces the volume of beneficial transactions, as seen when good-quality used cars are withdrawn from the market.
Economic Mechanisms and Impacts
What is Gresham’s Law analogy in this context?
“Bad money drives out good” is analogous to bad products (lemons) dominating the market because high-quality goods are undervalued.
Economic Mechanisms and Impacts
What mechanisms help mitigate asymmetric information?
- Signaling: High-quality sellers provide signals, such as warranties.
- Screening: Buyers use methods like inspections or reviews to discern quality.
Policy and Market Interventions
How can regulations address asymmetric information?
Governments can enforce transparency through mandatory disclosures or quality standards.
Policy and Market Interventions
What are market solutions to asymmetric information?
Mechanisms like warranties, guarantees, or third-party certifications reduce uncertainty.
Policy and Market Interventions
How does adverse selection affect insurance markets?
High-risk individuals are more likely to buy insurance, increasing costs for insurers.
Policy and Market Interventions
What are some solutions to adverse selection in insurance?
Group insurance or mandatory participation helps pool risks and reduce costs.
Applications and Broader Relevance
How does asymmetric information affect labour markets?
Employers may struggle to distinguish between high- and low-productivity workers. Education credentials act as signals of quality.
Applications and Broader Relevance
How does asymmetric information impact financial markets?
Borrowers know more about their ability to repay loans than lenders, who rely on credit scores or collateral as signals.
Applications and Broader Relevance
What is an example of asymmetric information in healthcare?
Doctors have more information about treatments than patients, leading to potential overcharging or unnecessary procedures.
Applications and Broader Relevance
How do online markets address asymmetric information?
Platforms like eBay or Amazon use rating systems to mitigate information gaps.
Evaluation
Why is asymmetric information significant in microeconomic theory?
It explains many real-world market inefficiencies and has wide applicability in understanding market dynamics.
Evaluation
How has Akerlof’s model shaped modern economics?
It has highlighted the need for policymakers and businesses to design mechanisms that reduce the adverse effects of asymmetric information, promoting more efficient and equitable markets.