Question

The company you are working for has a problem. Its products are clearly superior to competitors but consumers seem unwilling to buy your products over the more well-known competition products. The managers have proposed certain solutions: 1) Expand the advertising budget to increase brand awareness; 2) Cut the prices to encourage cost-conscience buyers.

Required:

What is Information Asymmetry?

From Akerlof’s perspective, why are consumers more likely to buy from your competitors when you know your product is better?

Having read Akerlof in your Accounting Theory class – discuss the pros and cons of each of these approaches in addressing the fundamental problem of Information Asymmetry.

Which approach do you think will be most effective in accomplishing the goal of communicating quality and reducing the uncertainty of the consumers?

Answer 1

1) INFORMATION ASYMMETRY:- In simple words it is a situation where one party has greater material knowledge than the other party in a transaction. This normally in transaction between seller and buyer, seller has more knowledge on that product or service ( reverse is also possible). So this situation is called Asymmetric information

For example- If you want to buy a second hand car, you go to a seller to buy it, but by seeing the car you don't whether the car is good or bad, unless you experience it you don't know how the car is. On the other side seller may know the whole information about the car. This situation is called Asymmetric information.

2) According to Mr. Akerlof's perspective consumers are more likely to buy from your competitors when you know your product is better because of the 'Adverse selection'.

George Akerlof in his 1970's seminal paper "THE MARKET FOR LEMONS", described the concept of asymmetric information. As lemons and peaches look alike, he compared them with buying of a used car. Suppose a buyer would pay $1000 for a good car ( consider good car as 'peach'), but only $500 for a malfunctioning car( consider malfunctioning car as 'lemon'). As lemons and peaches are hard to distinguish, buyers may willing to pay $750 for a car, they perceive that the car may be lemon or peach. The seller who has peach i,e good car will reject the buyer as the worth of the car is $1000. The seller who has lemon i,e malfunctioning car will accept the buyer's proposal as the worth of the car is $500. In this situation buyers will face "Adverse selection". Smart buyers will think that if the seller is accepting the proposal of selling a car at $750 then the car must be a lemon, he will switch to other sellers. Other normal buyers due to Adverse selection will go to the competitors due to asymmetric information.

3) PROS:- Growing asymmetrical information is desired outcome of a market. As workers specialize and become more productive in their fields they can provide greater values to workers in other fields.

One alternative to ever expanding asymmetric information is for workers to study in all fields rather than specialize in fields where they provide the most value.

To make information available in the internet which is inexpensive

CONS- Asymmetric information may lead to Adverse selection or moral hazard

The risk of buying the product by this information is very high

4) In my point of view in accomplishing the goal of communicating quality and reducing the uncertainty of the consumers should be done by expanding the advertisement budget and increase the brand awareness.

Because cutting the cost is a operational strategy and it is a internal function of the company. As we want to reduce the uncertainty of the customers and communicate the quality of the products we should advertise the products and increase the brand awareness. By doing this pull strategy, consumers will come to know about the product and he will gain as much information as possible which reduces the uncertainty and leads to sale of the product.