- Imperfect information is where the buyer lacks information about prices and buyers’
behaviour determines how informed they are
- Asymmetric information is where one side lacks more information than the other and this
lack of information determines behaviour. Markets may only provide low quality goods.
Main body:
- When consumers have perfect information on prices they receive all of the benefits from
trade; they can always move to the firm with the lower price if products are homogeneous
and/or can satisfy their preferences with products that are vertically and/or horizontally
differentiated
- However, if people don’t know prices and finding info on prices is costly to them; a firm
might increase prices marginally to now make more profit/start making supernormal profit
from previously making normal profits. If the price rise is very minimal such that the cost of
acquiring info on what other prices are is more expensive than just buying the product then
the firm will not lose consumers. Other rivals may also retaliate by marginally raising their
prices over that of the other firm and hence price keeps rising until both firms price at the
consumer’s max willingness to pay; hence when consumers are uninformed on prices and
finding info is costly they receive none of benefits from trade; prices go from being at the
same level of perfect competition to the same level as monopoly due to imperfect info.
Unravelling principle
- Where firms may have incentives to provide info and even full information in some cases.
- Unravelling principle holds if:
1. There are differences between products which consumers care about
2. Firms can make costless, credible statements about products
- Reason firms will give complete info is that if consumers have info at all they will assess all
firms as average and so will buy from all stores at random.
- However, the firm offering the best terms is better than average so should give full info to
consumers as to how it is the best firm and hence it will attract more consumers. The firm
that can offer the largest consumer surplus which is greater than the expected average
surplus of all the firms in the market for the consumer should inform consumers that it can
offer the largest surplus.
- Once the firm fully reveals info to consumers on why it is the best everyone will want to buy
from them however they will likely have capacity constraints and so are unlikely to be able
to supply everyone.
- An uninformed customer will then perceive the rest of the firms as average and expect the
same surplus from each however again out of all the firms remaining the one offering the
best terms will have an incentive to give full information to customers in order to profit
maximise and attract all the remaining consumers
Asymmetric information
- Several cases where buyers have less info than sellers (usually on quality of good):
- Search goods: easy to assess quality post and pre purchase
- Leads to the problem of adverse selection
- Costs less for a firm to buy/produce a low quality good than a high quality good
- Consumers willing to pay higher for high quality than low quality
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