A2.03.08: Forms of Asymmetric Information

Question 1

Define Asymmetric information

Answer 1

• When the information exists but is not being shared equally between two parties

Question 2

Name 2 markets that asymmetric information is involved greatly in

Answer 2

• Labour market
• Second-hand markets

Question 3

How is there asymmetric information within labour markets

Answer 3

There is asymmetric information between the employers and the potential workers
- The potential worker has got all the info about their own features as a worker, their productivity, their skills and their work ethic

• However, this information is not available to the employers and they are desperately trying to get it however it is not going to be perfect
• This may result in employers making irrational decisions to employ a worker thus, not maximising their benefits because of the information not being equally shared

Question 4

How is there asymmetric information within second-hand markets

Answer 4

In second-hand car markets, it’s always the buyers that lack the information but the seller has all the information about the state of the car
- The buyer doesn’t necessarily have all the information about the car as it isn’t being shared perfectly by the seller

• This may result in the buyer making an irrational decision to purchase that car even though it won’t maximise the utility of the buyer

Question 5

How are insurance markets linked with moral hazards

Answer 5

If an individual is gaining insurance but doesn’t actually bear the cost of taking risks, the insurance company bears that cost

• This can lead to moral hazard because the individual takes more risks as they are not going to bear the costs of those risks as the insurance company will bear the risks for them
• This is not in the best interest of the insurance company nor for society but it happens as the right individual does not pay for the excessive risks that are being taken.
• Thus, in this case, the insurance company bears the cost and no the individual

Question 6

Define Adverse Selection

Answer 6

A situation when there is asymmetric information between a buyer and a seller BEFORE A DEAL leading to an adverse market decision being made

Question 7

Explain adverse selection in terms of the less knowledgable party and the more knowledgable party

Answer 7

• Puts the LESS knowledgable party at a disadvantage as it’s more difficult for them to assess the value or risk of the deal
  .
• Puts the MORE knowledgable party at an advantage as they have access to all the relevant info and can more easily evaluate the quality of the agreement

Question 8

Draw the diagram if seller was more knowledgable than the consumer (like second had markets)

Answer 8

• price costs benefits ($)
• MPB (fuller info) > MPB (limited info)
• MPC curve

Question 9

Draw the diagram if the buyer was more knowledgable than the consumer (like moral hazard [insurance markets])

Answer 9

• Price costs benefits (S)
• MPC (fuller info) > MPC (limited info)
• MPB curve