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Asymmetric information is an economic model that examines what happens when one party in a transaction knows more than another. For instance, an antique buyer may have researched a set of rare antiques meticulously before showing up to an estate auction and thus may know much more about a certain piece of art than the seller does. The informational asymmetry between buyer and seller can lead to a variety of dilemmas and interesting situations. In particular, information asymmetries cause two problems: adverse selection and moral hazard.
In the case of adverse selection, one party to an agreement uses asymmetric information before a transaction for personal gain. For instance, a person who is sick may hide that information from a prospective insurer in order to qualify for lower premiums. Likewise, a person with a high-risk lifestyle may attempt to buy more insurance in order to avoid costly medical bills. In other words, the buyer knows something about his health that his insurer doesn’t. He leverages this asymmetric information unfairly to his advantage to get a better price. The insurer, meanwhile, suffers financially.
A moral hazard results when an information asymmetry develops after the fact. For example, if a person is issued a credit card with no spending limit and proceeds to spend beyond his or her ability to pay, resulting in a default, this would be considered moral hazard. The credit card company absorbs the bulk of the consequences of the consumer's irresponsible behavior. Likewise, if a country's government has a bailout policy for its banking industry, banks may be more inclined to make unsecured or risky loans, unbeknownst to the government; the bank hopes for the revenue gains from high interest rates, but knows it won't lose too badly because the government will unwittingly cover the losses. The increased likelihood of risky behavior based on asymmetric information is the basis of a moral hazard.
The pioneers of information asymmetry concepts, George Akerlof, Joseph Stiglitz, and Michael Spence, began writing about these theories back in the 1960s. In particular, Akerlof’s book, The Market for Lemons, demonstrated that informational asymmetries can and do lead to immoral economic decisions. In severe situation, they can even lead to the decline and dissipation of entire markets.
Thanks to the advent of online resources, such as public message boards, today’s consumers can leverage asymmetric information for their advantage. For instance, buyers can research insurance rates, car prices, and restaurants and hotels online and learn a lot about what fellow consumers have said about the businesses. In the past, these buyers had much less information to use when formulating judgments about services or companies. Nevertheless, this advantage is a double-edged sword. While the Internet does provide consumers leverage, businesses can also leverage online resources to develop or even expand their informational advantages over consumers. For instance, companies can now use online market research tools to determine the viewing and clicking habits of consumers and thus develop marketing campaigns to take advantage of meticulously sourced consumer habits.