2.1.6

Information Gaps

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Information Needed for Decision-Making

Purchases are based on a belief that a particular good or service will provide satisfaction. These beliefs are based on information. So, information is very important for purchase decision-making.

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What is asymmetric information?

  • A situation of asymmetric information happens when both parties in a transaction have an unequal amount of information.
  • Asymmetric information can cause a decline in prices or quantity of products sold.
Illustrative background for The 'Lemons' problemIllustrative background for The 'Lemons' problem ?? "content

The 'Lemons' problem

  • Consider Marvin, who is buying a used car from a dealership.
  • The car could either be a 'lemon', which is a defective vehicle, or a high quality vehicle. Because of asymmetric information, Marvin does not know which the car is.
    • This is called a misallocation of resources.
  • This limits his ability to make a rational choice and pay the appropriate price for the car.

Implications of Imperfect Information

Imperfect information can discourage buyers and sellers from participating in the market.

Illustrative background for Thin and thick marketsIllustrative background for Thin and thick markets ?? "content

Thin and thick markets

  • If buyers and sellers are discouraged from participating in the market, there will be fewer active in the market.
  • This is a thin market.
  • If there are many buyers and sellers, it's called a thick market.
Illustrative background for Price signallingIllustrative background for Price signalling ?? "content

Price signalling

  • Buyers with imperfect information often think that price signals product quality.
    • E.g A Michelin-starred restaurant selling expensive food is often assumed to be of better quality than a cheaper alternative, like McDonalds.
  • When buyers use market price to make assumptions about quality, markets can struggle to reach an equilibrium price and quantity.

Merit and Demerit Goods - Imperfect Information

Imperfect information is when buyers and sellers have unequal information. It can lead to the over and under consumption of goods in the free market.

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Merit goods

  • Consumers take into account only the private benefit.
  • If they had perfect information, they might realise the additional benefits a merit good can bring.
    • E.g they may realise how beneficial education is.
Illustrative background for Demerit goodsIllustrative background for Demerit goods ?? "content

Demerit goods

  • Consumers only realise the private gain.
  • If they had perfect information, they might realise the negative effects consumption of the good can bring.
    • E.g consumers may not realise the effect smoking can have due to imperfect information.

Jump to other topics

1Introduction to Markets

2Market Failure

3The UK Macroeconomy

4The UK Economy - Policies

5Business Behaviour

6Market Structures

7A Global Perspective

8Finance & Inequality

9Examples of Global Policy

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