Imperfect Information and Asymmetric Information

Information is key to the growth and development of economies as it leads to better working conditions. If a company has proper information, they have the advantage of performing better than others. In a perfect competition economy, information is freely available to all players, who don't have to hide. Consumers know the features and prices of the products they buy, where manufacturers understand what is needed to produce their goods and services. No product has better features than others, and the cost of production and distribution is much lower. A perfect competition offers equal competition to all firms that operate within. No company can be said to be bigger than the others, and hence, they are price takers.

But we know that such a market only exists in theory. It is only best used as an example of what a real market should be like. Many economies exist under imperfect competition where monopolies and other firms that are bigger than other exist. Larger firms can set the prices of their goods high based on consumers' willingness to buy their products. Conclusion this means consumers are price takers, and unlike the perfect competition, it gives good incentives for new players to enter the market.

It is all about the availability of information. In economies with perfect information, every player can access the information whenever they want, and however, they see fit. Imperfect competition, on the other hand, does not have proper incentives to share information freely. Those who have more information are unwilling to share as they use it for their own benefit. And those who don't have any information in these markets are left to struggle.

In this course, we shall be looking specifically at imperfect information and asymmetric information. This is an area of economic studies that carries a lot of weight in determining economic growth and development. We are living in the information era where technologies like social media have changed the way people relate and how they share information. Companies are taking advantage of these technologies to connect with their customers, sharing with them all the information they see fit. Social media has changed the world into a global village, something that would not have been imagined a few years ago. And those who that the ability to connect with their audiences have the advantage of staying ahead.

Understanding imperfect information and Asymmetric information

Think about a good or service that many people during the most important times of life. Expensive jewelry has been used for many generations to mark important moments. People buy them as gifts for their loved ones to show their affection and make it seem like they live in the most important times. Celebrity psychologist Doree Lynn once bought an expensive high-end ring from a jewel dealer in 1994, in Washington DC. This piece of jewelry featured an emerald worth $14,500. After several years, the emerald fractured, forcing her to take to another jeweler who found the cracks were filled with resin. Lynn was so disappointed the took legal action against the original jeweler for selling her a treated emerald without telling here in the first place. This was the beginning of another discovery in the world of emerald jewelry, as many people came to understand little-known facts about these precious stones. It was discovered that many of them have internal flaws, which forces jewelers to soak them in clear oil, or resin to hide the flaws and make the color deeper clearer. This treatment can leak after some time, and the epoxy resin can discolor with age or as affected by heat. But this does not mean that using clear oil and epoxy to fill the emeralds is illegal, only that it has to be disclosed.

During the case following Lynn's lawsuits, a TV show called "Dateline" on NBC acquired four emeralds from four different stores in NY 1997. In these stores, the sales clerks all said all their stones were untreated, but they did not know that they were secretly recorded. The emeralds were taken for testing in the laboratory, which discovered that all the stones were treated. These the same things seen with other precious stones like diamonds, topaz, and tourmaline gemstones are also treated to make them more attracted. As stated above, treating gemstones is not illegal, but the general rule is that it has to be revealed clearly. In many cases, however, sellers just want to make a sale, and hence, they do not disclose this important information. This is where buyers are faced with asymmetric information. Two players are involved in a transaction, in which they have an unequal amount of information, one party has more knowledge about the product than the other party.

This is a very common situation in many economic situations where imperfect information exists. Either the buyer, the seller, or both parties have less than 100% certainty about what they want to buy or sell. There could be certain important qualities about the product that is hidden from the other party, and the party that knows this is less willing to share, perhaps for fear of losing something important in the transaction. Imperfect information does complicate an economic transaction in goods, labor, and financial capital markets. For instance, imperfect information can easily lead to a decline in the prices and quantities of goods sold.

Nevertheless, buyers and sellers are often incentivized to find ways to reach mutually beneficial agreements, even if they are imperfect information. The relationship between consumers and suppliers in markets is based on trust and information availability. When companies want to attract more buyers, they use the sweetest terms that make the information seem helpful. Buyers and sellers need to make mutually beneficial transactions so that each goes home satisfied.

So, what is the difference between imperfect and asymmetric information? There are certain features that make these two terms different, even though they are largely applied to mean the same thing. A market is said to be at equilibrium when sellers and buyers have full information about the product's price and quality. In the beginning, we said that in perfect competition, every party is well informed about the product or service; that is an equilibrium. If the information is limited, buyers and sellers may not transact well or make poor decisions. Another aspect of the economic theory is that human beings are faced with decisions on a daily basis, which they must make to live well. These decisions are made based on the available decisions. Being rational decision-makers, people will always go for things that help them achieve their main goal in life, which is to achieve happiness.

Imperfect information is where buyers or sellers lack the necessary information to make an informed decision concerning the product's price or quality. They have already made the decision that they need the product, only that now there is no proper information to help them make the final decisions. And therefore, imperfect information is where a buyer and/or the seller does not have all the information they need to make an informed decision. Asymmetric information, on the other hand, is a situation wherein one of the players, either the seller of the buyers, knows more about the product's quality and real pries than the participant in the transaction. The similarity comes in majorly due to the lack of information on at least one side of the transaction, and in both situations, the parties need remedies to make good decisions.

Consider this example the Charles is trying to make a decision to either buy a car or not. Assuming the Charles does not have any clue about a car's engine, he may be forced to do some research, using materials like consumer reviews or other material that information about the specific car he intends to buy. Also, he may go ahead a pay a mechanic to check the car and make sure it is in good condition. Even after going through all this trouble, and even using money to prove quality, he may still not be sure this is a good choice. Perhaps he will go home, and after using it for a few weeks, the car can no longer work. In another scenario, this buyer knows about used cars, he now finds two cars that have the same features, but one costs $2000 and the other $2500. The answer is simple here if Charles is working in a world of perfect information. But since he is in an imperfect information market where the seller might know more about the problems with their cars than they may be willing to share, Charles will still be in a dilemma. More problems mean a lower price, but there is no way of telling whether the more expensive product is any good.

These are the same problems faced in the labor and financial capital markets. The risk of selling or buying a product without useful information can be very high. Consider a person who is looking for a job, and they apply for one after seeing and advertisement. The potential employer is concerned with ending up with a poor-quality worker, just like buying a used car in the example above. Hence, the employer will look for all information they can find about the applicant, going through their academic and work history qualifications. Still, these are not enough to tell the employer everything they need to know, and depending on the degree of uncertainty, the employer will still have doubts about abilities, which will be hard to tell without seeing the worker in action. How will an employer know where the persons they have chosen are right for the job, more than the others interviewed? They use other information, like awards, high-school grades, and accolades as an indication for hard work, perseverance, and other qualities needed for the job. Another way would be for the employer to reference for insights into the main attributes, such as energy level and work ethics. Once they have the right information and abilities, employees will create more ways of ensuring quality work.

Imperfect information effects on Equilibrium Price and Quantity

The existence of imperfect information can have negative impacts on and economic process. On one side, buyers can be discouraged from participating in a market because they cannot prove the product's quality in question. And on the other hand, those selling high-quality or medium quality good may become reluctant to take part in a transaction because they don't have enough incentives to prove to their buyers that these are quality goods. And if buyers cannot be convinced that what they are buying is quality, they will not be willing to pay a high price for such goods. In either case, one of the parties may not be satisfied if they close the transaction.

If there are few buyers and few sellers in a market, economists refer to it as a thin market, which means the opposite is a thick market. When the impact of imperfect information is severe, the markets can become extremely thin. Small numbers of buyers and sellers may try to offer enough information about their goods until they agree on the price.

When prices mix with imperfect information about price, it creates a whole new market of an idea. A buyer who is facing imperfect information may look for clues about the quality of the product in the price. For instance, one can assume that a used car that costs higher is of better quality, even if they don't have much expertise on used cars. When you enter and expensive restaurant, you assume that the food must be really good because of the price. In short, the market prices are often used to determine the value of the said products; in this case, the markets will have no trouble reaching a price equilibrium.

Issues of imperfect and asymmetric information are resolved in different ways. For instance, buyers and sellers of certain goods rely on the reputation of the brands, as well as guarantees, warranties, and service contracts. The labor market issues licenses and certificates to assure competency. The goods market can use incentives like a money-back guarantee that assures quality. These strategies are important in ensuring the inexistence of thin market.

Author: James Hamilton