Asymmetric information

Imperfect knowledge

Imperfect information exists in situations

where either the buyer or seller has less
than complete information about the quality
of the product they are purchasing, meaning
that it will not be possible for the market to
reach the allocative efficiency level of
output.

For example, diagram 1 illustrates the used

car market. The seller will typically have
much greater information about the quality
of the car than the potential
buyer. Concerned that the car they are
trying to purchase maybe a lemon, the
buyer is not prepared to pay above
MPB. The seller, in return, is only prepared
to offer a below quality car, given that even a high quality one will fetch a price below the
socially optimum price. The result is that the equilibrium price will be below the socially
efficient price and too few second hand cars will be traded - this is illustrated in the diagram
to the right, where both price and output are below the socially optimum level. This also
explains why there is a market for second
hand car dealerships offering an element of
quality / guarantee in exchange for a higher
price.

The second diagram, by contrast, illustrates

the opposite situation, where the seller is
less informed than the purchaser, for
example the market for private medical
insurance. In this case the purchaser is more
aware of their own health than the supplier
of the service. Concerned that each person
they provide cover for may be in worse
health than they claim, the seller is only
prepared to provide coverage at MPC, rather
than the socially optimum level of
MSC. This means that the final selling price
ends up higher than the socially optimum price and again few resources are diverted to the
production of that good or service. This is because some potential consumers, classified as
risky will not be offered coverage, while some healthy customers, unprepared to pay the high
price of premiums will decide not to pay for the service.

© Mark Johnson,
InThinking www.thinkib.net/Economics 1
Activity 1

Describe examples of markets where either the seller or the buyer has more information about
the product being sold?

Activity 2

What actions can a government take to smooth the path of information in such markets?

Activity 3: A focus on the provision of medical coverage in the private sector

Explain how imperfect knowledge impacts on the market for private medical coverage, in
nations without universal public provision

© Mark Johnson,
InThinking www.thinkib.net/Economics 2