Imperfect information

Market for lemons

Asymmetric information

Signaling

Contingency clause

Information advertising

Persuasive advertising

Markets may not be efficient in the case of:

Market power

Imperfect information

Externalities

Public goods.

Today we will talk about the problem of imperfect information.

Ex: Market for lemons (don’t worry about the graph)

Buyers may assume that all used cars are lemons, driving down the price of used cars.

How to avoid this problem? Try to add additional information in the form of a ‘signal.’

Ex: warranty

Can the price itself be seen as a form of information? Is so, what does this say about Supply and Demand analysis?

What other ways do individuals have of protecting themselves when there is an information asymmetry?

a. contract with contingency clauses

b. reputation (which can then become a barrier to entry creating market power!)

c. search for information

1. when information is costly you may see price dispersion

2. groups may form to help individuals search (Consumer Reports)

3. firms may provide information through advertising

When does advertising increase the efficiency of the market and when does it have the opposite effect?

When it provides information it increases efficiency and should lower price dispersion. At the same time advertising may be costly, and thus increase the per unit cost. (the graph on p. 298 thus is simplistic. Of course one could assume that advertising is a fixed cost and thus doesn’t affect the marginal cost of a unit.)

When advertising is persuasive it increases market power (and creates a barrier to entry), which then decreases efficiency.

Ex: beer commercial showing women in bikinis.

The slope and the location of the demand curve may alter so that the firm is able to raise its price and sell more!

Why do Coke and Pepsi both advertise? Does it change their market share?

Thus advertising can be viewed both as increasing and decreasing market efficiency!

What should the role of the government be, if information is assymetrical?

Government can:

pass consumer protection laws

make acting on certain types of information illegal (insider trading)