Question

3. What is asymmetric information? What are some common situations in which it occurs? What are some of the problems it can cause? What are some way to overcome these problems?   

Answer 1

asymmetric information: 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 its 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.

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 a 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. This is why the price of a second-hand car from big dealers is higher than from private seller.