3.4 MARKET IMPERFECTION - INFORMATION
Market imperfection can lead to market failure. One example of a market imperfection is information failure. Information failure can occur in two situations; Imperfect information and asymmetric information.
Imperfect Information
Imperfect information can occur when some, or all, market participants in an economic exchange don’t have perfect information. This can occur in any market. One of the assumptions of perfect competition is that there is perfect information for all economic agents. It is unlikely that there will ever be perfect information in a market, but an economic agent operating in the market should have as much information as possible. With perfect information, all agents will know the prices of other goods, the costs and benefits of consumption, the costs of producing goods etc.… perfect information allows the market to function efficiently and effectively. Without perfect information consumers may be consuming too much or too little of a good, as they don’t know the full private costs and benefits, consumers may also be exploited by firms who charge a high price because the consumers do not have a full knowledge of prices in other stores. Sometimes firms over state the benefits of their goods resulting in consumption being above the optimal level. One example would be cigarettes. Consumers do not know the full cost of smoking and therefore smoke more than they should (consumers over consume). Imperfect information can also lead to a lower level of consumption than is socially optimal. For example education, which could be under consumed because economic agents do not see the benefits. Imperfect information may lead to a total market failure, as the market is unable to function and can’t send signals or provide incentives.
A way to overcome imperfect information is to provide information in a more convenient place. For example, all alcohol now has how many units are in it on the back with a suggestion about how many units a person could have on average per day. Before this consumers were unsure as to what was the recommended max to drink per day. Some people would say that it is pointless and they will choose to ignore the additional information but at least the information is readily available. The number of units on alcohol is similar to adding nutritional information on food, in an attempt to encourage people to eat healthily.
There are also consumer protection laws and websites that inform consumers about their rights after purchasing a good which means that they can get a refund and not get taken advantage of by firms.
Most of these information programs are aimed at trying to change the perceived costs and benefits of consumption. If a consumer realises the negative effects which smoking can have on the individual and the surrounding individuals, then they may try to reduce their own consumption or stop all together. This changes the demand for the good/ service which will result in a reduction in output.
Imperfect information can occur when some, or all, market participants in an economic exchange don’t have perfect information. This can occur in any market. One of the assumptions of perfect competition is that there is perfect information for all economic agents. It is unlikely that there will ever be perfect information in a market, but an economic agent operating in the market should have as much information as possible. With perfect information, all agents will know the prices of other goods, the costs and benefits of consumption, the costs of producing goods etc.… perfect information allows the market to function efficiently and effectively. Without perfect information consumers may be consuming too much or too little of a good, as they don’t know the full private costs and benefits, consumers may also be exploited by firms who charge a high price because the consumers do not have a full knowledge of prices in other stores. Sometimes firms over state the benefits of their goods resulting in consumption being above the optimal level. One example would be cigarettes. Consumers do not know the full cost of smoking and therefore smoke more than they should (consumers over consume). Imperfect information can also lead to a lower level of consumption than is socially optimal. For example education, which could be under consumed because economic agents do not see the benefits. Imperfect information may lead to a total market failure, as the market is unable to function and can’t send signals or provide incentives.
A way to overcome imperfect information is to provide information in a more convenient place. For example, all alcohol now has how many units are in it on the back with a suggestion about how many units a person could have on average per day. Before this consumers were unsure as to what was the recommended max to drink per day. Some people would say that it is pointless and they will choose to ignore the additional information but at least the information is readily available. The number of units on alcohol is similar to adding nutritional information on food, in an attempt to encourage people to eat healthily.
There are also consumer protection laws and websites that inform consumers about their rights after purchasing a good which means that they can get a refund and not get taken advantage of by firms.
Most of these information programs are aimed at trying to change the perceived costs and benefits of consumption. If a consumer realises the negative effects which smoking can have on the individual and the surrounding individuals, then they may try to reduce their own consumption or stop all together. This changes the demand for the good/ service which will result in a reduction in output.
Asymmetric Information
Markets will work effectively when both consumers and producers have the same level of knowledge about a product. This is known as symmetric information.
Asymmetric information is where one agent knows more than another agent in the market. This can occur in various different situations.
It especially occurs in the insurance market with respect to health care and car vehicles. With car insurance, insurance companies cannot judge the true risk of an individual. Instead they have to pool risk. Insurance companies try to find out who are the risky individuals by offering a discount for driver who installs a black box. A black box measures the acceleration, braking intensity, speed and many more variables, and this information can be used to offer discounts for more responsible drivers and price hikes for less responsible drivers. With respect to health care insurance, you as the individual know more about your lifestyle risks than the person on the phone who is quoting you. You know if you smoke, have a risky lifestyle (such as doing extreme sports), your health history etc. It is the job of the insurance broker to ask questions to try and assess your risk level. They will also put in terms and conditions that will void the contract if certain activities were undertaken.
Another example is mortgages loans. Only you as an individual know your ability to keep up the mortgages repayments. To overcome this, mortgage providers will look at your credit scores and will require proof of your income levels. In addition, the Bank of England has stepped in to say that only 15% of mortgage should be allowed to be at or greater than 4.5%. This is an attempt by the Bank of England to control house prices and the level of individuals’ private debt in the hope to avoid another crisis.
Doctors have a better level of knowledge about what treatments to recommend to their patients. In a country where healthcare is private, meaning a company is aiming to make a profit, a doctor may suggest a treatment that is not necessary, or suggest a drug which is more expensive than another, which would be a misallocation of resources.
Another example is insider trading. The stock market is where individuals and institutions go to buy and sell shares. Everyone is meant to have the same knowledge of the stocks that are available on the market. However, it does not always work out that way due to some individuals having an unfair advantage. The most common advantage is having additional information, which is unavailable to the public. This information allows you to make money from undertaking certain trades. For example, suppose that you are working in a company that is just about to buy another company (this usually results in an increase in the share price of that company), and you decide to buy shares before it is initially announced. Also, you tip off a friend or family member who then buys shares and also makes money from having this unfair advantage. This is known as insider trading and is illegal for anyone who has acted unfairly on the information. However, it is incredibly hard to prove, as you need hard evidence such as an email, recorded phone call or someone who is willing to give a statement against the individual who leaked the information.
Markets will work effectively when both consumers and producers have the same level of knowledge about a product. This is known as symmetric information.
Asymmetric information is where one agent knows more than another agent in the market. This can occur in various different situations.
It especially occurs in the insurance market with respect to health care and car vehicles. With car insurance, insurance companies cannot judge the true risk of an individual. Instead they have to pool risk. Insurance companies try to find out who are the risky individuals by offering a discount for driver who installs a black box. A black box measures the acceleration, braking intensity, speed and many more variables, and this information can be used to offer discounts for more responsible drivers and price hikes for less responsible drivers. With respect to health care insurance, you as the individual know more about your lifestyle risks than the person on the phone who is quoting you. You know if you smoke, have a risky lifestyle (such as doing extreme sports), your health history etc. It is the job of the insurance broker to ask questions to try and assess your risk level. They will also put in terms and conditions that will void the contract if certain activities were undertaken.
Another example is mortgages loans. Only you as an individual know your ability to keep up the mortgages repayments. To overcome this, mortgage providers will look at your credit scores and will require proof of your income levels. In addition, the Bank of England has stepped in to say that only 15% of mortgage should be allowed to be at or greater than 4.5%. This is an attempt by the Bank of England to control house prices and the level of individuals’ private debt in the hope to avoid another crisis.
Doctors have a better level of knowledge about what treatments to recommend to their patients. In a country where healthcare is private, meaning a company is aiming to make a profit, a doctor may suggest a treatment that is not necessary, or suggest a drug which is more expensive than another, which would be a misallocation of resources.
Another example is insider trading. The stock market is where individuals and institutions go to buy and sell shares. Everyone is meant to have the same knowledge of the stocks that are available on the market. However, it does not always work out that way due to some individuals having an unfair advantage. The most common advantage is having additional information, which is unavailable to the public. This information allows you to make money from undertaking certain trades. For example, suppose that you are working in a company that is just about to buy another company (this usually results in an increase in the share price of that company), and you decide to buy shares before it is initially announced. Also, you tip off a friend or family member who then buys shares and also makes money from having this unfair advantage. This is known as insider trading and is illegal for anyone who has acted unfairly on the information. However, it is incredibly hard to prove, as you need hard evidence such as an email, recorded phone call or someone who is willing to give a statement against the individual who leaked the information.