Information Gaps
These Edexcel A-Level Economics revision notes cover unit 1.3.4, explaining how asymmetric information — where buyers and sellers have different levels of knowledge — leads to market failure through adverse selection and moral hazard, and how policy can reduce these gaps.
The Problem of Asymmetric Information
A key assumption of perfect market efficiency is perfect/symmetric information, where buyers and sellers have equal, complete knowledge.
In reality, information gaps and asymmetric information are common.
Information gaps: a situiation where one party lacks the information needed to make an informed decision.
Asymmetric information: a situiation where one party in a transaction has more or better information than the other.
These can distort decision-making and lead to market failure.
Consequences of Asymmetric Information
Information gaps:
Information gaps: can cause consumers to over/under-consume goods and services, leading to a misallocation of resources and market failure.
For example: a consumer may underconsume healthcare check-ups due to lack of information about their benefits, including the long-term value of preventive care such as catching cancers early.
Asymmetric information:
Asymmetric information: can lead to consumers making poor decisions, such as purchasing low-quality goods or services.
For example: a consumer may purchase a used car without knowing about defects that the seller is aware of and hiding, leading to a loss of utility.
Result: Market Failure
Asymmetric information causes a misallocation of resources.
Markets may over-provide low-quality or harmful goods because buyers are unaware of defects.
Markets may also under-provide high-quality or beneficial goods because buyers cannot identify them.
This results in a loss of allocative efficiency.
Exam Preparation
- Key terminology: Define and distinguish between symmetric information, asymmetric information, adverse selection, and moral hazard.
- Apply examples: Use clear examples such as used cars for adverse selection and insurance for moral hazard.
- Application: The VW emissions scandal is a strong example of producers hiding negative information.
- Link to intervention: Information gaps can justify government action such as regulation, compulsory vehicle MOTs, legal requirements like food labelling, or the provision of independent advice.