A) The distinction between symmetric and asymmetric information
Asymmetric information occurs when the consumer and producer have different levels of information available to them. The best example of this is in the insurance market. The insurance company can only make the decision whether or not to insure the consumer based on the information that the consumer gives out. For example, when trying to get car insurance, the insurance company needs to know information such as how many crashes the driver has been involved in, the age of the driver etc. From this information they will decide the cost of car insurance to the consumer. The problem with this is that the consumer may withhold or understate some information, leading to the firm giving them a better deal than they would have if they had the same level of information as the consumer. As a result of this, the insurance company makes an irrational decision to offer the consumer insurance at a lower price. An example of when the firm has more information than the consumer can be found in the car market. When a car dealer is selling to a consumer, they are likely to know much more information about the car then the consumer does. For example, the car dealer is likely to know the best and worst qualities of the cars they sell as well as any problems that the cars may have. Although they know these details, they may decide to only disclose certain details to the consumer in order to try and get as much money from the sale of the car as possible. If the consumer only has the information about the best aspects of the car, then they are likely to overvalue its worth. This will lead to a misallocation of resources, as the consumer ends up paying more for the car then it is actually worth.
This is in contrast to symmetric information, which occurs when the consumer has the same level of information as the firm does. Symmetric information is likely to occur in markets where there are high levels of transparency. Consumers have been able to gather more and more information with the rise of the internet. For example, when buying items online consumers can often see other people’s reviews for the products. As a result, they are more able to make an accurate valuation of the product and whether the price is correct for the benefit they will receive through consuming the product. The introduction of product reviews has increased the information available to consumers and therefore reduced the extent to which information between the consumer and producer is asymmetric. Overall, this has improved the allocation of resources in the online shopping market.
B) How imperfect market information may lead to a misallocation of resources
A lack of information can often lead to irrational decisions being made by both consumers and producers. This can be linked into the topic of externalities. For example, consumers often make irrational decisions such as the consuming cigarettes due to a lack of information. They may not know the full risk of smoking as they have never been provided this information. Therefore, although the costs of smoking cigarettes outweigh the benefits, the consumer may not know this and therefore make the irrational decision to smoke cigarettes regardless of this fact. This leads to the overconsumption of demerit goods where consumption is at the private optimum point rather than the social optimum point thus causing a misallocation of resources.
Information gaps can also be linked to the under consumption of merit goods such as education.