Information Failure
Information failure – type of market failure where individuals or firms have a lack of information about economic decisions
a) The distinction between symmetric and asymmetric information
Information asymmetries:
Situation where there’s imperfect knowledge
Where one party has access to information that another party doesn’t
• E.g. when selling a car, the owner is likely to have full knowledge about its service history and likelihood to break down. The potential buyer, by contrast, won’t – he may not be able to trust the car salesman.
Failure to disclose information
In many economic transactions, agents may not make full disclosure
• E.g. when applying for health insurance, you may fail to inform about genetic traits or current ill health. • When purchasing financial assets, the buyer may not be aware of the risk involved – an issue in period before the credit crunch.
Leads to information asymmetries
Difficulty in estimating costs and benefits
Difficult to be aware of social costs of good – accounting costs are easier to know but not external costs
• E.g. The private costs to a firm producing energy from coal powered stations can be measured (labour costs, costs of coal) But, the external costs from releasing CO2 into the atmosphere are very difficult to accurately measure – requires estimates about monetary cost of pollution both now and in future – very difficult to know future costs and benefits because there are many uncertainties – e.g. what will be the real economic cost of global warming.
Lack of education / awareness
Merit and demerit goods have degrees of information failure with consumers unaware of the true personal cost / benefit.
• E.g. there was a time when many people weren’t aware of the ill-effects of tobacco on health. • Recently, there has been increasing concern about the health costs of sugar consumption. Many consumers are unaware of the amount of sugar in processed food and the harmful effects of sugar on health (Sugar Tax)
Framing issues
When making decisions over whether to purchase a good, consumers will be influenced by how the good is portrayed
• E.g. a firm may advertise an orange drink as a healthy fruit drink, with added vitamin C (gives consumer impression they are buying a healthy drink) but, hidden in ingredients are very high levels of processed sugar. Drinks companies may even hide levels of sugar, by calling the sugar ‘dextrose’ or ‘glucose’ – so perception can be different to the reality.
Moral Hazard
Occurs if there’s information asymmetry or if a contract affects the behaviour of two different agents
Occurs when individuals alter their behaviour because of certain guarantees
• E.g. an insurance firm may be willing to offer insurance against a bike being stolen but the firm may not realise that through offering insurance, it alters consumer behaviour and, after gaining insurance, the consumer takes less care to lock it up so the insurance company loses out because it is more likely to pay out than previously expected. • The government may offer a guarantee of bank deposits, but this could cause bank to take more risks and increase likelihood government has to bailout banks.
Irrelevant information/ misinformation
If applying for a job, a firm may search on the internet and find a Facebook post from several years ago. The employer may use this and avoid giving job – even though it is no longer relevant to whom you are now. Alternatively – may be false information / slander circulated which is hard to deny.
Information bias
The government has set up regulators to deal with natural monopolies, e.g. gas and electricity. The regulator aims to set fair prices for industry and consumers but if they rely on information from the firm, they may become sympathetic to the firm and allow price rises – known as regulatory capture – where regulators act in a favourable way to the firm they are regulating.
b) How imperfect market information may lead to a misallocation of resources
Smoking and Information Failure
Solution to market failure:
Taxing tobacco – more expensive for consumers
Reducing supply of cigarettes
Banning advertisement on smoking
Hiding cigarettes in shops
Getting rid of branding on cigarettes and introducing plain packaging
• Only really affects teenagers who want to look ‘cool’ by smoking particular brands rather than adult consumers
Health campaigns to warn consumers of the danger of smoking
Banning smoking in certain public places
All these solutions can be counteracted by:
Addiction – causes people to make irrational decisions and they may ignore solutions like taxing and still buy the product – inelastic demand
Black market may start to grow in influence if cigarettes are over-regulated
Information Failure in Society
Healthcare – Private healthcare could utilise asymmetric information to increase profits as consumers lack the information in relation to treatments
Finance – The cause of the financial crisis was down to information failure, both between the parties in the financial sector and between mortgage lenders and borrowers
University Applications – As an individual we know our ability but the university only has the interview, personal statement and application to understand our ability