What is Asymmetric Information?

1016 reads · Last updated: December 5, 2024

Asymmetric information, also known as "information failure," occurs when one party to an economic transaction possesses greater material knowledge than the other party. This typically manifests when the seller of a good or service possesses greater knowledge than the buyer; however, the reverse dynamic is also possible. Almost all economic transactions involve information asymmetries.

Definition

Information asymmetry, also known as 'information failure,' refers to a situation in economic transactions where one party has more substantial knowledge than the other. This often manifests as sellers of goods or services having more knowledge than buyers, although the reverse can also occur. Almost all economic transactions involve some degree of information asymmetry.

Origin

The concept of information asymmetry was first introduced by economist George Akerlof in his 1970 paper 'The Market for Lemons: Quality Uncertainty and the Market Mechanism.' He used the example of the used car market to explain how information asymmetry can lead to market failure. Akerlof was awarded the Nobel Prize in Economics in 2001 for this work.

Categories and Features

Information asymmetry can be divided into two main types: adverse selection and moral hazard. Adverse selection occurs before a transaction, where due to information asymmetry, inferior products or bad customers are more likely to be selected. Moral hazard occurs after a transaction, where one party may change their behavior due to information asymmetry, increasing the risk to the other party. Features of information asymmetry include asymmetric information, incomplete information, and information opacity.

Case Studies

A typical case is the insurance market. Insurance companies often cannot fully know the health status or lifestyle of policyholders, which can lead to adverse selection, where high-risk individuals are more likely to purchase insurance. Another example is credit transactions in financial markets, where banks may not fully understand a borrower's repayment ability, leading to moral hazard, where borrowers may engage in riskier behavior after obtaining a loan.

Common Issues

Common issues investors face with information asymmetry include how to acquire more information to reduce asymmetry and how to assess the authenticity of information. A common misconception is that information asymmetry is always detrimental to transactions; in reality, understanding and leveraging information asymmetry can provide a competitive advantage to investors.

Suggested for You

Refresh

The Lisbon Treaty, also known as the Treaty of Lisbon, updated regulations for the European Union, establishing a more centralized leadership and foreign policy, a proper process for countries that wish to leave the Union, and a streamlined process for enacting new policies.The treaty was signed on December 13, 2007, in Lisbon, Portugal, and amended the two previous treaties that established the foundation for the European Union.

Lisbon Treaty

The Lisbon Treaty, also known as the Treaty of Lisbon, updated regulations for the European Union, establishing a more centralized leadership and foreign policy, a proper process for countries that wish to leave the Union, and a streamlined process for enacting new policies.The treaty was signed on December 13, 2007, in Lisbon, Portugal, and amended the two previous treaties that established the foundation for the European Union.

Labor Intensive

The term "labor-intensive" refers to a process or industry that requires a large amount of labor to produce its goods or services. The degree of labor intensity is typically measured in proportion to the amount of capital required to produce the goods or services: the higher the proportion of labor costs required, the more labor-intensive the business.

Labor Intensive

The term "labor-intensive" refers to a process or industry that requires a large amount of labor to produce its goods or services. The degree of labor intensity is typically measured in proportion to the amount of capital required to produce the goods or services: the higher the proportion of labor costs required, the more labor-intensive the business.

Fast-Moving Consumer Goods

Fast-moving consumer goods (FMCGs) are products that sell quickly at relatively low cost. FMCGs have a short shelf life because of high consumer demand (e.g., soft drinks and confections) or because they are perishable (e.g., meat, dairy products, and baked goods).They are bought often, consumed rapidly, priced low, and sold in large quantities. They also have a high turnover on store shelves. The largest FMCG companies by revenue are among the best known, such as Nestle SA. (NSRGY) ($99.32 billion in 2023 earnings) and PepsiCo Inc. (PEP) ($91.47 billion). From the 1980s up to the early 2010s, the FMCG sector was a paradigm of stable and impressive growth; annual revenue was consistently around 9% in the first decade of this century, with returns on invested capital (ROIC) at 22%.

Fast-Moving Consumer Goods

Fast-moving consumer goods (FMCGs) are products that sell quickly at relatively low cost. FMCGs have a short shelf life because of high consumer demand (e.g., soft drinks and confections) or because they are perishable (e.g., meat, dairy products, and baked goods).They are bought often, consumed rapidly, priced low, and sold in large quantities. They also have a high turnover on store shelves. The largest FMCG companies by revenue are among the best known, such as Nestle SA. (NSRGY) ($99.32 billion in 2023 earnings) and PepsiCo Inc. (PEP) ($91.47 billion). From the 1980s up to the early 2010s, the FMCG sector was a paradigm of stable and impressive growth; annual revenue was consistently around 9% in the first decade of this century, with returns on invested capital (ROIC) at 22%.

Negotiable Instruments

A negotiable instrument is a signed document that promises a payment to a specified person or assignee. In other words, it is a formalized type of IOU: A transferable, signed document that promises to pay the bearer a sum of money at a future date or on-demand.Common examples of negotiable instruments include personal checks, cashier's checks, money orders, certificates of deposit (CDs), promissory notes, and traveler's checks. The person receiving the payment, known as the payee, must be named or otherwise indicated on the instrument. Because they are transferable and assignable, some negotiable instruments may trade on a secondary market.

Negotiable Instruments

A negotiable instrument is a signed document that promises a payment to a specified person or assignee. In other words, it is a formalized type of IOU: A transferable, signed document that promises to pay the bearer a sum of money at a future date or on-demand.Common examples of negotiable instruments include personal checks, cashier's checks, money orders, certificates of deposit (CDs), promissory notes, and traveler's checks. The person receiving the payment, known as the payee, must be named or otherwise indicated on the instrument. Because they are transferable and assignable, some negotiable instruments may trade on a secondary market.

Renewable Resource

A renewable resource is a resource that can be replenished naturally over time. As a result, it is sustainable despite its consumption by humankind.Renewable resources for the production of energy are considered especially important for their potential to replace non-renewable, or finite, resources. Additionally, renewable resources can offer cleaner energy solutions than those provided by non-renewable resources such as coal and fossil fuels.Examples of renewable resources include the sun, wind, water, the earth's heat (geothermal), and biomass.

Renewable Resource

A renewable resource is a resource that can be replenished naturally over time. As a result, it is sustainable despite its consumption by humankind.Renewable resources for the production of energy are considered especially important for their potential to replace non-renewable, or finite, resources. Additionally, renewable resources can offer cleaner energy solutions than those provided by non-renewable resources such as coal and fossil fuels.Examples of renewable resources include the sun, wind, water, the earth's heat (geothermal), and biomass.

Feasibility Study

A feasibility study is a detailed analysis that considers all of the critical aspects of a proposed project in order to determine the likelihood of it succeeding.Success in business may be defined primarily by return on investment, meaning that the project will generate enough profit to justify the investment. However, many other important factors may be identified on the plus or minus side, such as community reaction and environmental impact.Although feasibility studies can help project managers determine the risk and return of pursuing a plan of action, several steps should be considered before moving forward.

Feasibility Study

A feasibility study is a detailed analysis that considers all of the critical aspects of a proposed project in order to determine the likelihood of it succeeding.Success in business may be defined primarily by return on investment, meaning that the project will generate enough profit to justify the investment. However, many other important factors may be identified on the plus or minus side, such as community reaction and environmental impact.Although feasibility studies can help project managers determine the risk and return of pursuing a plan of action, several steps should be considered before moving forward.