What is Asymmetric Information?
851 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.
