Transcript Market Failure: Asymmetric Information

Market Failure:
Asymmetric Information
• Where the buyer or seller had more
information than the other party
• Means that the price is not determined on full
information – one or other party is making an
uneducated assessment of opportunity cost or
perceived welfare benefits
Second Hand Cars – Akerlof’s Model
• George Akerlof (1970) first outlined the problem using
2nd hand cars example:
• Owners know the full story of the car – buyers don’t
• Buyers are only willing to pay ave. prices for all cars – less
than average quality & more than average quality
• So sellers tend not to sell better-than-average quality
cars because they cannot get a high enough price AND
sellers tend to get more money for less-than-average
quality cars because buyers don’t know any better
Second Hand Cars – Akerlof’s Model
• Until... buyers catch on: now buyers aren’t willing to pay
the old price, leading to even ave. quality cars not
fetching enough for sellers to be happy
• According to Akerlof, eventually the market will
disappear
• In reality, the market exists because buyers have more
information than the model suggests, but still prices for
1-day-old cars are well below the ticket price of the new
car because of asymmetric information
Principal Agent Problem
• The goals of the principals (those standing to
gain or lose from a decision) are different from
those of the agents making the decisions on
behalf of the principals
• Eg. Shareholders vs. managers
• Eg. Children vs. parents
Education
• Suffers the ‘principal agent problem’ – principals are
children, agents are parents
• Child suffers asymmetric info so parent has to act in
interests of the child - encouraging achievement of eventual
goals of the child
• But, in some cases, the parent doesn’t act in the best
interest of the child for selfish reasons – the goals of the
agent are different to those of the child (eg. parent wants
the child at home to work & improve profits for the parent)
• The state has to try to overcome these conflicts for the
good of the child and of society
Pensions
• Asymmetric info. means workers pay too little
into pensions when they are young (and the
pension can do the most growing for them!)
• Young people can’t imagine growing old & ignore
the potential loss of welfare from not starting
early enough (opp. cost of saving seems too high)
• State forces savings through National Insurance
contributions & other taxes which fund state
pensions
• Other savings are encouraged through tax breaks
on pension schemes & regular savings
Drugs
• Users have asymmetric information – they undervalue
the loss in future welfare from current drug / alcohol /
tobacco use
• Sellers often have more information than they share (eg.
drug dealers have probably seen people in terrible
trouble on drugs, but do not divulge it to their
customers!)
• State often campaigns to educate people on the future
consequences
Health Care
• Asymmetric info and principal agent problems exist
• Patients do not know about their health and treatment,
but doctors do
• Doctors should be acting as agents for patients,
recommending what it best for them
• But doctors (& dentists) may recommend what is most
profitable, rather than what is best for the patient
• Also, patients hide information (moral hazard) when
buying life insurance so insurance co’s have to find ways
of estimating this information and may overcharge