Information is very important, so what happens when one party knows more than the other?
Asymmetrical information is when one party knows more about the good or service being purchased than the other, resulting in the other party not receiving a product or payment of equal value to their product or payment. For example, a person selling a house will know more about it than the buyer and may not mention any negative factors that could lower its value, such as noisy neighbours, leaking ceilings, or being in a dangerous area. As a result, the buyer will only realise that the house is not worth as much as they paid for it after moving in, as the previously unknown factors will reduce its utility and thus value them. So it was an unfair exchange where the seller profited more from the transaction, and the buyer overpaid. Alternatively, using the same example, the buyer may be willing to pay more for the property as it meets their requirements perfectly, but the seller does not know this. Resultantly, they do not get as much money as they should, which results in the new homeowner owning a property more valuable to them than the money they exchanged for it and the seller losing out on additional profit.
Although this individual situation would not cause any significant damage to the market, information asymmetries on a national and international scale can cause severe market failure. We see this in pharmaceutical companies like Pfizer and AstraZeneca, both prominent names due to their vital vaccines to combat the COVID 19 pandemic. If one of these companies knew about but withheld information about the side effects of their vaccines, such as the recent concerns about AstraZeneca’s vaccine causing blood clots, this would create an information asymmetry between the company and the countries who have purchased and utilised the vaccine. The consequences would be that the millions that the vaccine had already been administered to would be at risk of developing blood clots, leading to more serious issues like cardiovascular disease. It would cause public uproar and pressure healthcare systems to deal with more complex problems that are expensive to treat. There would also be the problem of the millions of doses that have been bought but not yet used, which would be wasted as the vaccine would be deemed unsafe. This results in whole nations losing millions or even billions of dollars. This situation would be the same in almost all developed countries worldwide that could afford the vaccine in large quantities. These same countries are heavily involved in global trade, so that the market would fail worldwide. In this case, the market failure could be prevented by doing clinical trials before releasing the vaccine to the general public to ensure it is safe.
Not all information asymmetries are harmful, and often they are preferred in specific fields such as the labour market. If one person is better at fixing power lines and the other is more knowledgeable about trading in the stock market, this is an information asymmetry. However, this is actually positive as it allows people to be specialised in a specific field of work, which relates to Adam Smith’s theory about specialisation and the division of labour. So, they can do a better job than someone who knows a bit about many different positions and can earn more money by providing a higher quality service. Furthermore, the two people can rely on each other to do what they are best at, as the electrician would prefer someone experienced to manage their portfolio in the stock market, nor would the trader allow a random person to possibly cause further damage to their home. Information asymmetries would also be necessary when dealing with sensitive information. This can be explained using banks. If you are a customer at a particular bank and hold an account with them, you would not want an employee there to know your account details as they could abuse this power and steal your money. To prevent this, there is an information asymmetry where you know more information about your specific account than the bank to protect your privacy.
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