Information Gaps

EdExcel Economics 1.3.4

What is meant by Information Failure?

• In competitive markets, it is assumed there is perfect information – i.e. consumers and producers have full knowledge about prices, benefits and costs of the goods and services available.

• There are many causes of information failure1. Long-term consequences: Information gaps about long term benefits

of costs of consuming a product e.g. consumption of legal highs2. Complexity: Information failure when a product is highly complex e.g.

understanding the best pension product to buy (if at all!)3. Unbalanced knowledge: i.e. when the buyer knows more than the

seller, or the seller knows more than the buyer4. Price information: When consumers are unable to quickly / cheaply

find sufficient information on the best prices for different products

Information failure occurs when people have inaccurate or incomplete data and so make potentially ‘wrong’ choices / decisions

Examples of Information Failure

In nearly every market we find instances / risks of information gaps

Risks from using tanning salons

Addiction to painkillers & other

drugs

Gaining entry to elite degree

courses

Complexity of pension schemes

Uncertain quality of second hand

products

Knowledge of the nutritional content

of foods

Cowboy builders or other “rip-off

merchants”

Tourist Bazaars or buying and selling

antiques

Information Gaps & Market Failure

Costs, Benefits

£s

Output / quantity

MPC

P1

Q1

MPB (limited information)

P2

Q2

Individuals may have imperfect information about their own private benefits. If they had better information on the benefits to themselves of consuming a good or service, the marginal private benefit curve would shift outwards leading to a higher equilibrium quantity

MPB (fuller information)

Market demand would be higher if consumers had better information

Obesity Rates in Selected Countries in 2014

Saudi Arabia

United States

Germany

China

India

0.0% 10.0% 20.0% 30.0% 40.0% 50.0% 60.0% 70.0% 80.0%

69.4%

67.4%

61.1%

28.3%

19.5%

Percentage of the populationSource: University of Washington

According to the latest data for the UK, 25% of adults in England are obese. A further 37% are overweight. Obesity is normally defined as having a BMI of 30+

Asymmetric Information in Markets

1. Landlords who know more about their properties than tenants2. Mortgages: A borrower knows more about their ability to repay a

loan than the lender, insufficient checks might be made3. Car insurance companies cannot tell the risks associated with

selling premiums to each single driver – they have to pool risks4. Some students have superior knowledge about how to get into the

elite / best universities including which prior courses to take5. Doctors have superior knowledge about drugs and treatments 6. A used-car seller knows more about vehicle quality than a buyer7. Insider information of traders in financial markets8. Information advantages for high-frequency stock market traders

Asymmetric information is when there is an imbalance in information between buyer and seller which can distort choices

Moral Hazard and Adverse Selection

These are two aspects of asymmetric information in insurance markets

• Moral Hazard• Moral hazard occurs when insured consumers are likely to take

greater risks, knowing that a claim will be paid for by their cover• The consumer knows more about his/her intended actions than

the producer (insurer)• Adverse Selection

• Health insurance: those most likely to purchase health insurance are those who are most likely to use it, i.e. smokers/drinkers/those with underlying health issues

• The insurance company knows this and so raises the average price of insurance cover

• This prices healthy consumers out of the market, meaning that only high risk individuals gain insurance – a market failure

Policies for Addressing Information Failures

1. Compulsory labelling on products (cigarettes)2. Improved nutritional information (labelling

systems) on food & drinks3. Hard-hitting anti-speeding advertising to

reduce the number of road accidents4. Campaigns to raise awareness of the risks of

drink-driving / drug abuse5. Campaigns on dangers of gambling addiction6. Performance league tables for schools7. Consumer protection laws e.g. right for

refunds of faulty goods8. Industry standards / guarantees for selling

used products such as second hand cars

Government action can improve information to help consumers and producers value the actual cost and/or benefit of a good or service.

Everyone quits eventually

Stick to the speed limit

Information Economics: Car Insurance Market

• In 2012, there were 30 million motor insurance policies in the UK

• From 2008 through to 2011 there was a surge in insurance premium costs

Consumer price index for vehicle insurance

Index of insurance costs, 2005 = 100

2008 105.0

2009 115.8

2010 151.5

2011 186.8

2012 188.1

2013 185.1

What factors might explain the rise in car insurance premiums?1. Increasing number of fraudulent

claims e.g. for whiplash injuries2. Rising volume of claims linked to

increased car ownership and traffic congestion

3. More claims from personal injury lawyers & car hire firms

Significance of high insurance prices1. Higher premiums cut into

disposable incomes of motorists2. Rise in the number of people

who choose to drive uninsured3. Younger drivers badly affected –

many annual premiums exceed the market value of the vehicle

Factors Influencing Buyers of Used Cars in the UK

What most strongly influences the type of used car you would consider buying?

Personal experience make/modelViews family friends

TestdriveInternet shopping/consumer sites

Classified used car websitesConsumer reports

Used car showrooms/sitesCars on street

Motoring magazinesDealer websites

Car TV showsDealer advice

Car manufacturer advertsFacebook/twitter

0.0% 5.0% 10.0% 15.0% 20.0% 25.0% 30.0%28%

26%16%16%

11%10%10%

9%7%

6%4%4%4%4%

Share of respondents

The used car market has plenty of asymmetric information because potential buyers of a vehicle know less than the seller about the car’s quality.

Information Gaps

EdExcel Economics 1.3.4