"Asymmetric information, sometimes
referred to as information failure, is present whenever one party to an
economic transaction
possesses greater material knowledge than the other party. This normally
manifests itself when the seller of a good or service
has greater knowledge than the buyer, although the opposite is possible. Almost
all economic transactions involve information asymmetries.
Asymmetric information is the
specialization and division of knowledge in society as applied to economic
trade. For example, medical doctors tend to know more about medical treatment
than their patients; after all, those doctors specialize in medicine, while
their patients do not. The same principle applies to manufacturers, teachers,
police officers, attorneys, restaurant operators and yoga instructors, or any
other specialized profession.
Economic Advantages
Growing asymmetrical information
is a desirable outcome of a market economy. As workers specialize and become
more productive in their fields of expertise, they can provide greater levels
of value to workers in other fields. For example, a stockbroker’s services are
less valuable to customers who already know enough to buy and sell their own
stocks with confidence.
One alternative to ever-expanding
asymmetric information is for workers to study in all fields, rather than
specializing in those fields where they can provide the most value. This comes
with large opportunity costs and would likely result in a lower level of aggregate
output, lowering standards of living.
Another alternative is to make
information abundantly and cheaply available, such as through the internet.
This does not replace asymmetric information, however. It only has the effect
of moving information asymmetries away from simpler areas and into more complex
areas.
Possible Problems
In certain circumstances,
asymmetric information may lead to adverse selection or moral hazard. These are
situations where individual economic decisions are hypothetically worse than
they would have been had all parties possessed more symmetrical information.
Most of the time, the solutions to adverse selection and moral hazard are not
complicated.
Consider adverse selection in life
insurance or fire
insurance. Higher-risk insurance customers, such as smokers, the
elderly or those living in dry environments, may be more likely to purchase
insurance. This could raise insurance premiums for all customers, forcing the
healthiest to drop out. The solution is to perform actuarial work and insurance
screening, then charge different premiums to different customers based on
potential risk."
Source: Article 'Asymmetric Information' published on Investopedia
“Following the seminal work of
Stiglitz and Weiss (1981), a large theoretical literature has stressed the key
role of asymmetric information in lending markets. A majority of studies shows
that asymmetric information can generate market failures such as credit
rationing, inefficient provision, mispricing of risk, and, in the limit, market
breakdown. Moreover, a financial crisis can exacerbate the negative effects of
adverse selection and moral hazard in financial markets (Mishkin 2012).
Deepening our understanding of the extent and effects of asymmetric information
is key for the design of a regulatory framework that limits their negative
consequences. The theory has analysed the effects of asymmetric information
mostly under the assumption of a perfectly competitive credit market, an
assumption that is not likely to hold in many relevant markets.
Correspondingly, there is no clear evidence of the effects of the interaction
of asymmetric information and imperfect competition in lending markets.” As
stated in article titled ‘Asymmetric information and imperfect competition in
lending markets’ on Voxeu.org
