Question

Give examples of asymmetric information and explain how companies and consumers deal with asymmetric information?

Answer 1

Answer:--- This is a situation where there is imperfect knowledge. In particular, it occurs where one party has different information to another. A good example is when selling a car, the owner is likely to have full knowledge about its service history and likelihood to break-down. The potential buyer, by contrast, will be in the dark and he may not be able to trust the car salesman.
Asymmetric information can lead to adverse selection, incomplete markets and is a type of market failure.When looking at a car, a buyer can only see the externals and not see under the bonnet.

Overcoming Asymmetric information

-Invest in the business – give signals.WIth second-hand car markets. If you were buying from a one-off private buyer, you would have reasons to be suspicious about the quality of the car. However, if a second-hand car dealer invests in large property and advertising, it is a signal that the firm intends to stay in the long-term. In this case, the firm has a greater incentive to sell reliable cars and avoid costs to its reputation.
-Give warranties. Another way to avoid asymmetric information is for second-hand car salesmen to give warranties for the reliability of their car.
-Employ a mechanic to test car. If you are going to buy a second-hand car for £7,000, it would be worth paying £100 to a qualified mechanic to run the car through independent tests. This would give you more information. Also, the car dealer would be wary of trying to sell ‘duds’ if you were bringing a qualified mechanic to test.
-No claims bonuses. To overcome asymmetric information in insurance, insurers will give big discounts for ‘no claims bonuses’ this is the best way of gaining better information about ‘careful’ and ‘unlucky’ consumers.

Thank You