Power of Information Asymmetry– Business of- Lemons: Seller Vs. Buyer Scale of Transparency…

A ‘lemon’: No, it’s not about citrus fruit, it’s about problems that arise in markets when there’s ‘information asymmetry’. Asymmetric information occurs when seller has more, or better information than buyer… When consumers are unable to fully assess, due to lack of information, things that they are buying– there is always a chance they are going to get a ‘lemon’…

The ‘lemons’ problem theory was described by George Akerlof in 1970 paper titled: The Market for Lemons: Quality Uncertainty and Market Mechanism, for which George Akerlof, Michael Spence, and Joseph Stiglitz jointly received the Nobel Memorial Prize, in Economic Sciences in 2001…

Their research centered around the ideas of asymmetric information… and they used metaphor of ‘lemon’ as it related to poor-quality and pricing of used-cars… Akerlof challenged the consensus of the time, and he used the term– ‘perfectly competitive general equilibrium model’, in which competition makes it impossible for seller (or buyer) to set or influence the price of goods…

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In the article Information Failure by Richard H. Cass R. Sunstein write: It can be argued that markets work best (more efficient) when information is perfect and is evenly shared by all parties in a transaction. Hence, asymmetric information is an economic problem because one party can exploit their greater information or knowledge… There are many examples of information failure associated with economic transactions, e.g.; Job applicant, who fails to reveal full information about their work skills… Estate agent seller, who does not disclose all relevant information about piece of property and possible problems… Cigarette manufacturer, who does not inform smokers of true health risk of smoking… Buyer of financial product, who is unaware of the true level of risk… Seller of a pension, who misleads purchasers about the financial value of the pension…

When parties to a transaction are ignorant (lack information) of certain aspects of the transaction, e.g.; quality of the goods they are buying, they often just make a decision just based on price– a buyer may assume that goods are of poor-quality, if price is low… or, assume that goods are of high-quality, if price is high… When George Akerlof analyzed the problem he associated it with pricing used-cars, which he called ‘lemons market’– a ‘lemon’ is a derogatory term for a poor quality used-car. However, the lemon’s problem has many wider implications in terms of understanding information failure in markets, generally… Hence, whenever there is information failure there is the possibility that the markets will become ‘lemons markets’…

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In the article Information Asymmetry: Empowering Consumers by Grace Nasri writes: Until recently– and even depending on the market– there has been an unbalanced distribution of information between buyers and sellers– merchants have long-held the advantage… With full information over consumers, they’ve had the power to set prices and hide crucial information about products and services, leaving buyers at the mercy of sellers…

Consumers had few resources for unbiased information, where they could go to find average prices for goods and services in markets– from real estate and autos to careers and travel. This information asymmetry negatively affecting consumers, business, competitive market in general… Consumers often must make decisions based on partial information… Too often, the only information consumers have is information provided by the same merchants, who were trying to make the sale– biased and incomplete…

Consumers would often end-up paying far above true value… Worse, some hapless buyers ended-up with ‘lemons’, a term coined to describe used-cars found to be defective only after they had been purchased… At the same time, honest businesses that sold quality products at reasonable prices would often lose out to manipulative counter-parts who masked sub-par products with big-budget marketing ploys and slick Ads… An efficient market depends on buyers making rational decisions, and buyers can only make rational decisions when they have equal access to the same information as sellers (and reverse is true for sellers)…

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In the article End of Asymmetric Information by Alex Tabarrok and Tyler Cowen write: Market institutions are rapidly evolving to a situation where very often buyer and seller have roughly equal knowledge… Technological developments are giving everyone who wants it access to the very best information, e.g.; product quality, worker performance, matches to friends and partners, nature of financial transactions, and among many other areas…

However, with increased advancements in technology, asymmetric information has been on the decline as a result of more people being able to easily access all types of information, especially with Internet and social media… And there are growing number of companies that see the ‘business of information’ as an outstanding opportunity… and they are beginning to shift the balance of information asymmetry back to the consumers… This shift toward a more balanced distribution of information benefits both consumers and business alike…

In the article Buyer Still Beware by David Auerbach writes: Technological developments are giving everyone who wants it access to the very best information… However, what many people fail to observe is that ‘the very best information’ is not 100% pure but cut with inferior data ranging from unreliable accounts to deceitful garbage… The problem is not even noisy signals per se, but too many signals… According to Tabarrok and Cowen; a lot of economic theories about asymmetric information, while logically correct, have been rendered empirically obsolete… But have they?

For example; recently asymmetric information has become a flash point in the health care wars– economists and policymakers debate what it means when patients know more about their health than insurance companies… when doctors know more about medicine than their patients (or insurance companies), and when nobody knows what’s wrong with many of patients in the first place… More generally the Internet has caused society to experience a transition from a scarcity of signals to a surfeit of signals.

More information means more good information, but also more bad information… The amount of information available on any given transaction can be more than a single person or agent can possibly process… We are now in a world where there is vastly more to know, yet most people’s cognitive capacities remain what they were in the Stone Age…

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In the real world, everyone is not equally in the dark– in every situation some people usually know more than others… According to Thomas G. Clark; the claim by some experts that information asymmetry ‘is on the decline’ when in fact the opposite is true and that information asymmetry is now more prevalent than ever, and that it can be seen as the root cause of the global economic meltdown… The rise of digital technology hasn’t just improved capacity of the individual to access valid information, but it’s also greatly increased capacity for agents to produce deliberately asymmetrical information…

According to Rafael Hurts; Internet empowers some consumers; but some consumer are marginally literate; some are innumerate; some are naive; some are stupid; some are just beginning to develop dementia… According to Suw Charman-Anderson; the simplest of information asymmetry problems has many names, e.g.; some call it, ‘price transparency’ or simply ‘transparency’…

But this over simplifies and undervalues the problem, since just having transparency does not always mean that you get the best deal…