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Initially, the seller has some information that the buyer does not have;
there is asymmetric information. As a result, D1 represents the
demand for the good and Q1 is the equilibrium quantity. Then, the
buyer acquires the information that she did not have earlier and there
is symmetric information. The information causes the buyer to lower
her demand for the good so that now D2 is the relevant demand curve
and Q2 is the equilibrium quantity. Conclusion: Fewer units of the
good are bought and sold when there is symmetric information than
Asymmetric
Information
in a Factor
Market
Initially, the buyer (of the factor labor), or the firm, has some information that the
seller (of the factor) does not have; there is asymmetric information. Consequently,
S1 is the relevant supply curve. W1 is the equilibrium wage, and Q1 is the
equilibrium quantity of labor. Then, sellers acquire the information that they did
not have earlier, and there is symmetric information. The information causes the
sellers to reduce their supply of the factor so that now S2 is the relevant supply
curve, W2 is the equilibrium wage, and Q2 is the equilibrium quantity of labor.
Conclusion: Fewer factor units are bought and sold and wages are higher when
there is symmetric information than when there is asymmetric information
Is There Market Failure?
• Asymmetric information seemingly resulted in “too much”
or “too many” of something – either too much of a good
being consumed or too many workers working for a
particular firm.
• The point is whether or not the asymmetric information
fundamentally changes the outcome from what it would be
if there were symmetric information.
• The presence of asymmetric information does not guarantee
that the market fails. What matters is whether the
asymmetric information brings about a different outcome
than the outcome that would exist if there were symmetric
information. If this occurs, the case for market failure can
be made.
Adverse Selection
• Some economists argue that
under certain conditions,
information problems can
eliminate markets or change
the composition of markets.
• Adverse selection exists when
the parties on one side of the
market, who have information
not known to others, self –
select in a way that adversely
affects the parties on the other
side of the market.
• Asymmetric Information leads
to adverse selection.
Moral Hazard
• Asymmetric information
can also exist after a
transaction has been made.
If it does, it can cause a
moral hazard problem.
• Moral Hazard occurs
when one party to a
transaction changes his
behavior in a way that is
hidden from and costly to
the other party.
Q&A
• Give an example that illustrates how asymmetric
information can lead to more of a good being
consumed than if there is symmetric information.
• Adverse selection has the potential to eliminate
some markets. How is this possible?
• Give an example (not discussed in the text) that
illustrates moral hazard.