Wednesday, October 21, 2009

Why Asymmetric Information Exist?

In a standard textbook theory, a competitive market assumes that economic agents like buyers have perfect knowledge of the goods and services sold. This means a buyer knows about the quality of product being sold, its cost structure and information of the product is freely available. As such purchasing decision is made

In reality, all these don’t exist. There is always the case of information deficit which leads to market failure. Sellers always have an upper hand over buyers. They just know too many things that buyers don’t. As such they can take advantage of the situation

Consider the following:

(1) Car mechanic. Whenever you send your car to the workshop, there is a tendency that he will tell you that your car has all sorts of problem. There could be several parts that need to be changed. He could be so convincing that you give in just like that. After all, who wants to take the risk of car breaking down in the middle of night or road

(2) E-bay transactions. A seller overseas may prescribe their item as ‘NEW’ or even ‘ORIGINAL’ or ‘NO MISSING PARTS’. For the same item, they may not even display using the picture of their own. Instead they use the picture of the item from some other sellers. Are they trying to hide something? No buyers know for sure. In such circumstance, it leads to market failure as transaction is prevented especially for very pricey items as buyers do not want to take the risk

In short asymmetric information can be caused by the followings:

(1) Addiction.
Hardcore smokers and drug addicts maybe so addicted that they didn’t even realise the possible health problems they may be facing in near future. By the time they are aware, it could be too late already

(2) Misleading information. Companies that sell junk food often use persuasive advertisement to lure kids into consuming unhealthy stuffs. It may come along with free toys, interesting animation and of course making those kids in the advertisement look so cool when eating it. As such the demand for junk food can increase and the consumption will be more than optimal

(3) Uncertainties of costs and benefits. There is quite a number of young people I met who choose to drop out from school and start working at young age. That is because they see the short term monetary reward from working. However, they may not realise the potential private benefits accrued to them in the long run. Statistics have proven that on average employees with basic degree stand a better chance of earning much higher income than those who just possess O-:Level and A-Level. Another will be savings for retirement. Many young people choose to enjoy while young and start saving at later age. The problem is, they are unaware of the danger of getting into debts due to excessive spending. Also they are unaware of the point where they need to kick start savings

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