Revisiting Nobel Prize Winning Economic Theories
Market provides goods and services whose quality are sometimes difficult to judge in advance. Television, for instance, might look good in the shop, but for how long will it work? Warranties are one way of overcoming the uncertainty (The Economists, 2016). Why are brand goods popular? Why does a Burger King make more sales than a local competitor next door? Why do some people prefer to buy used cars from a used car salesman rather than from an individual? Of two job applicants with similar skills, why does the one with higher qualification get the job? All of the above, brands, used car salesmen, degrees and qualifications are examples of market institutions set in place to level information asymmetries (Auronen, 2003).
It is empirically clear that people possess different information. The information they possess affects their behaviour in many situations. Consider buying goods, for example, the seller adjusts the price of an item based on her knowledge of the prices of similar items on the market and the condition of the item among other factors. The buyer similarly can have information about the prices of similar items in the market. But what he probably does not have is the same depth of information about the quality of the item as its seller. There is clearly an information asymmetry between the two parties at issue (Auronen, 2003).
Possibilities of Asymmetric Information
Financial Markets: Asymmetric information could be seen in the debt contract. In this market the borrower has much better information about his creditworthiness than the lender who is providing loan. To some extent, the lender will try to overcome this by looking at past credit history and evidence of reliable salary. However, economic conditions and intrinsic uncertainty of the borrower can hamper the contract (Bebczuk, 2003). The consequence is that lenders will charge higher rates to compensate for the risk. If there was perfect information, banks wouldn’t need to charge this risk premium (Pettinger, 2017).
Insurance: Another instance can be while opting for health insurance, the insured party may not reveal information relating to past health ailments (if any) which causes a gap in the information between the insurer and the insured. This causes asymmetric information problem in the contract.
Labour Markets: When employing a worker, a firm doesn’t know what will be the performance of that employee pertaining to the job. The employer will refer to the resume and past references, but once employed, one cannot guarantee the attitude of the worker (Pettinger, 2017).
The end of Asymmetric information?
With the advent of the Information and Technology, the problem of the information failure is easy to resolve. Internet has triggered a revolution to create market transparency and easy access of information over the world. Internet disclosure offers firms the opportunity to enhance communication quality, improve reputation, attract potential investors, and reduce information distribution costs. It also helps the individuals to access, analyze and understand information, in order to make better informed decisions (Gajewski & Li, 2015). For example, when guests go to visit hotels and restaurants – they can look at online reviews to have a better idea what to expect. Selling second hand goods through market places like Ebay relies on sellers building up good reviews. Therefore, there is an incentive to only sell goods which are correctly marketed.
Therefore, the success of online business rest highly on the minimization of asymmetric information between the seller and buyers (Arbi, Kausar, & Salim, 2017). Some of old economic theories of asymmetric information may not apply in the new world of internet and artificial intelligence. However, it is a long established phenomenon which would continue if there is difference in perception and lack of transparent communication.
Arbi, K. A., Kausar, A. R., & Salim, I. (2017). Minimizing Asymmetric Information in Online Markets through Knowledge Management. International Journal of Management Excellence.
Auronen, L. (2003). Asymmetric Information: Theory and Applications.
Bebczuk, R. N. (2003). Asymmetric Information in Financial Markets: Introduction and Applications . Cambridge University Press.
Gajewski, J.-F., & Li, L. (2015). Can Internet-Based Disclosure Reduce Information? Elsevier.
Pettinger, T. (2017, August 28). Asymmetric information problem. Retrieved from Economics Help.
The Economists. (2016, September). What is information asymmetry?