Market Failure: Asymmetric Information

1
Market Failure Asymmetric Information

• Where the buyer or seller had more information
  than the other party
• Means that the price is not determined on full
  information one or other party is making an
  uneducated assessment of opportunity cost or
  perceived welfare benefits

2
Second Hand Cars Akerlofs Model

• George Akerlof (1970) first outlined the problem
  using 2nd hand cars example
• Owners know the full story of the car buyers
  dont
• Buyers are only willing to pay ave. prices for
  all cars less than average quality more than
  average quality
• So sellers tend not to sell better-than-average
  quality cars because they cannot get a high
  enough price AND sellers tend to get more money
  for less-than-average quality cars because buyers
  dont know any better

3
Second Hand Cars Akerlofs Model

• Until... buyers catch on now buyers arent
  willing to pay the old price, leading to even
  ave. quality cars not fetching enough for sellers
  to be happy
• According to Akerlof, eventually the market will
  disappear
• In reality, the market exists because buyers have
  more information than the model suggests, but
  still prices for 1-day-old cars are well below
  the ticket price of the new car because of
  asymmetric information

4
Principal Agent Problem

• The goals of the principals (those standing to
  gain or lose from a decision) are different from
  those of the agents making the decisions on
  behalf of the principals
• Eg. Shareholders vs. managers
• Eg. Children vs. parents

5
Education

• Suffers the principal agent problem
  principals are children, agents are parents
• Child suffers asymmetric info so parent has to
  act in interests of the child - encouraging
  achievement of eventual goals of the child
• But, in some cases, the parent doesnt act in the
  best interest of the child for selfish reasons
  the goals of the agent are different to those of
  the child (eg. parent wants the child at home to
  work improve profits for the parent)
• The state has to try to overcome these conflicts
  for the good of the child and of society

6
Pensions

• Asymmetric info. means workers pay too little
  into pensions when they are young (and the
  pension can do the most growing for them!)
• Young people cant imagine growing old ignore
  the potential loss of welfare from not starting
  early enough (opp. cost of saving seems too high)
• State forces savings through National Insurance
  contributions other taxes which fund state
  pensions
• Other savings are encouraged through tax breaks
  on pension schemes regular savings

7
Drugs

• Users have asymmetric information they
  undervalue the loss in future welfare from
  current drug / alcohol / tobacco use
• Sellers often have more information than they
  share (eg. drug dealers have probably seen people
  in terrible trouble on drugs, but do not divulge
  it to their customers!)
• State often campaigns to educate people on the
  future consequences

8
Health Care

• Asymmetric info and principal agent problems
  exist
• Patients do not know about their health and
  treatment, but doctors do
• Doctors should be acting as agents for patients,
  recommending what it best for them
• But doctors ( dentists) may recommend what is
  most profitable, rather than what is best for the
  patient
• Also, patients hide information (moral hazard)
  when buying life insurance so insurance cos have
  to find ways of estimating this information and
  may overcharge