2.1.2 Imperfect Information

Question 1

Summary

Answer 1

1. Importance of Information for Decision Making
2. Significance of Asymmetric Information
3. Market for Lemons

Question 2

1. Importance of Information for Decision Making

Answer 2

• When attempting to maximise utility, consumers often posses imperfect information.
• This can lead to ‘wrong’ decisions
• E.g. over consumption of demerit goods (tobacco)

Question 3

2. Significance of Asymmetric Information

Answer 3

• Sometimes one party to a market transaction, either the buyer or seller, suffers from imperfect information about the nature of the transaction.
• Asymmetric Information: when one party to a market transaction possesses less information relevant to the exchange than the other.
• This is often the result of adverse selection
• E.g. in the sale of a second-hand computers, the seller knows more about the computer’s defects than a potential buyer.

Question 4

3. The Market for Lemons

Answer 4

• Akerof: in the case of the car market, there are four kinds of cars.
• New cars, used cars, good cars and bad cars (or ‘lemons’ - American slang)
• Seller has a better idea of which cars are good than the buyers.