CH19 Information gaps Flashcards
in a perfect market, what do buyers and sellers both have potential access to? However, what are many decisions based on? and what does this mean there is?
in a perfect market, both buyers and sellers have potential access to the same information. There is symmetric information.
-however, many decisions are based on imperfect information. Both buyers and sellers dont find out the information they need to make the decision that maximises their welfare. There is then information failure or an information gap
when do information gaps also occur? and what does this mean there is?
information gaps also occur when either the buyer or the seller has more information than the other.
-there is then a situation of asymmetric information. The buyer or seller with more information can exploit that information gap to their benefit.
with information failure, describe what the demand and supply curve would look like if buyers overestimate the benefits of the product.
with information failure, there would be one supply curve and two demand curves. the first equilibrium (so the first demand curve) is the one where there is perfect information. However, the second demand curve will be to the right of the first one, where there is imperfect information.
with information failure, describe what the demand and supply curve would look like if buyers underestimate the benefits of the product.
there would be one supply curve, and two demand curves. The actual demand curve will be to the left of the demand curve with perfect information.
-too little will be bought at too low a price.
does the same analysis of information failure apply to suppliers?
yes it does.
-if they underestimate the benefits to themselves of selling a product, then the supply curve will be left to the left of the supply curve where they possess perfect information.
-if they overestimate the benefits, the supply curve will be to the right.
which economists first outlined the problem of asymmetric information?
George Akerlof
which example did George Akerlof use in his paper to discuss the problem of asymmetric information?
he used the example of second hand cars.
-he argued that buyers of second hand cars dont know whether any individual second-hand car is a good car or whether it is a ‘lemon’, a very poor quality car with significant defects.
-buyers therefore have to guess whether or not a second-hand car is of good quality. Because they dont know, they are only prepared to offer to pay average prices for better than average quality cars.
-owners of better than average quality cars therefore tend to not to sell them because they cant get a high enough price. But then second-hand cars for sale become mainly average or below-average quality. Buyers are then not prepared to pay average prices for a second-hand car and therefore start to offer below-average prices.
-owners of average quality cars then feel that they are not getting a high enough price for their car and so stop selling them in the market.
-George Akerlof argued that the final outcome was the disappearance of the market for second-hand cars
-Asymmetric information has led to the collapse of the market.
who do second-hand car markets still exist in practice despite what Akerlof demonstrated?
this is because buyers have more information than Akerlof’s model assumes.
-for example, consumer protection laws in the UK state that car dealers must sell cars which at minimum are road worthy. Second-hand car dealers may offer a short guarantee period of, say, three months.
-consumers can make some judgements about the second0hand car dealer by the state of their premises and the number of cars they are selling.
-the price of the car is also determined by its age and mileage. Consumers can find an approximate guide to the price of the car by buying a car price guide or looking at the internet.
-however, it remains true that the price of a day old second-hand car is, for the most part, significantly below the price of a new car. That difference in price in part reflects the discount in the market because of asymmetric information
what are the 5 other markets where asymmetric information can lead to a misallocation of resources and market failure?
1) education
2) pensions
3) drugs
4) financial services
5) advertising
what is meant by the principal-agent problem?
this occurs when the goals of principals, those standing to gain or lose from a decision, are different from agents, those making decision of behalf of the principal. Examples include shareholders (principals) and managers (agents), or children (principals) and parents (agents)
what does education provide an example of?
it provides an example of the principal-agent problem.
-in education, the principal is the child or student. The agents are the parents and guardians of the child and society in general represented in the UK by government agencies such as the school and the courts.
does a child/student suffer from asymmetric information?
yes.
-it, typically, does not see the long-term benefits of education. Therefore it may act in ways, such as truanting from school or failing to work to its potential, which act to harm its long-term interests.
-if allowed, it will devote too few resources to education and so there will be a misallocation of resources.
-agents for the child, therefore have to act in a way which will foster and encourage the child to participate fully in the educational process.
how can the problem of asymmetric information explain the issue with young workers not paying enough for their pensions?
-many 25-year-olds may not be able to imagine what it will be like to live as a 70 year old. As a result, they may ignore the loss of welfare that will come from having a low income at 70 to boost their current spending and immediate gratification.
-govs step in to remedy at least part of this misallocation of resources by forcing workers to save for their retirement.
how do drugs cause a misallocation of resources partly because of asymmetric information?
-individuals are sometimes unaware of the long-term costs of drug use. E.g. individuals are usually unaware of the medical risks to binge drinking. Individuals also typically fail to recognise that taking drugs can cause drug dependence. Manufacturers of legal drugs such as alcohol and tobacco are for more aware of the risks than most of their customers.
when does a moral hazard occur?
a moral hazard occurs when an economic agent, like a bank or banker, makes a decision in their own best interest knowing that there are potential adverse risks and that, if problems result, the cost will be partly borne by other economic agents
