For markets to function perfectly, all parties to an economic transaction should have perfect knowledge about the terms of the contract, the products and services that form the subject of the agreement and the prices in the market. In practice, the real commercial world rarely confirms to this ideal, and it is common for one of the parties to have better and/or more knowledge than the other, leading to imperfect competition and market failure. This situation is called asymmetric or imperfect information.
Asymmetric information or imperfect information, occurs where access to information by one party (or parties) to an economic transaction is better than access by another party.
Properly functioning markets provide a valuable service to society, because consumers are able to purchase the goods and services that best match their preferences. However, asymmetric information can be used as a source of power in determining the outcome of the transaction. As a consequence, the market will not achieve allocative efficiency, because one of the parties - in this case normally the consumer, pays a higher price for a product than they would have done if they had perfect knowledge. In a perfect market, consumer and producer surplus should both be maximised at the market price, i.e. the conditions are in place for a Pareto optimum allocation of resources.
A common example of where the buyer pays more for a good than is socially efficient is where the seller knows much more about the characteristics of that good than the buyer. For example where:
- the seller of a product knows it is faulty
- commercial ideas with technical aspects are hard to describe contractually, but privately known by innovators
- labelling of food products use alternative terms for ingredients consumers would normally avoid, e.g. various names for sugars such as glucose, sucrose and fructose
- firms may have no incentive to provide consumers with information in markets with a public good aspect
It is also possible that the consumer has more information than the seller. For example, purchasers with specialist knowledge of antiques may be able to buy a antique for a price less than its true market value from a private seller, who does not have this expert knowledge.
The government has a number of policy tools at its disposal to correct asymmetric information and to control externalities. These include taxes, education programmes and production regulation intended to increase the flow of information to consumers. Government may decide to intervene in the market to require producers to disclose critical information, such as mandatory product labelling. The objective of this government intervention may not be to alter consumption behaviour in particular, but to increase informed consumption. However, these measures can be expensive and ineffective and perceived as government interference in the free market.
The growth of computer ownership with access to the internet has reduced the opportunities for asymmetric information, as consumers are able to access greater details on products, prices and customer reviews.
Read the following article and discuss whether the marketing and sale of Sunny Delight in 2003 was an example of asymmetric information in practice.