ECONOMICS
The Benefits of Asymmetric Information
A short article I wrote at Imperial College discussing the benefits of asymmetric information, dated 2 December 2020.
Note: This article was written in conjuction with Adam Wood, Amalie Kjaer, Bastian Shi, Henry Jones and Tom O’Brien.
Asymmetric information is painted in a bad light and it is justified by countless examples throughout history. For example, it can be used to benefit individuals or organisations such as traders exploiting insider knowledge to create abnormal profits [1]. Asymmetric information has also been shown to contribute to financial crises when investors possess insufficient information and do not know the true value of a project when investing [2]. Generally, asymmetric information disproportionately benefits the party with additional information whilst other parties suffer the repercussions. This report argues why this is not always so and provides examples of both the positives and negatives of asymmetric information.
Despite asymmetric information contributing to market failures [3], some economists argue that asymmetric information is key in allowing market opportunities to emerge, thus providing a net benefit to society. Entrepreneurs can identify gaps within markets through the asymmetric information they hold regarding the market or their individual cognitive abilities (innovation), allowing them to exploit opportunities, thus increasing social surplus [4].
Furthermore, as people are not omniscient, people develop specialities, such as stockbrokers and their developed understanding of market forces [5]. These specialists are then able to leverage their knowledge to create wealth for others, receiving an agreed fee. This wealth increase for the unspecialised customer would not have been realised without the asymmetric information of how markets and stocks behave. Other examples include doctors and real estate agents — skilled individuals who provide services to others.
With information more accessible than ever, it is always within the best interests of companies to have a reputation of being honest and fair with their customers as reviews of sellers can be easily circulated [5]. This implies that asymmetric information only has short-term advantages for companies who operate on a fraudulent basis since they will likely be found out eventually. Organisations can also serve as ‘quality certifiers’, i.e. review sites such as Consumer Reports where consumers can pay to obtain information about a product or service [6, 7]. Asymmetric information can present opportunities for businesses to make a profit by selling information.
In cases where asymmetric information can cause adverse selection, legislation can be put in place to minimise the negative effects as well as increase the availability of information [8]. Furthermore, asymmetric information is necessary for specialist occupations. It would be interesting to explore how fake news plays a role in the buyer-seller dynamic since the buyer will have perceived knowledge that is false [9]. The authors believe that asymmetric information can have a net benefit to society; in the context of a global pandemic, we are grateful that there are specialists who can save peoples’ lives and develop a vaccine. Conversely, in cases such as second-hand car sales, one is less likely to blindly trust the party with the additional information, showing that it is difficult to make generalisations regarding asymmetric information and that the context of the transaction is key.
[1] Wu, W. (2014) Information Asymmetry and Insider Trading. University of Chicago Booth School of Business. Available from: https://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.828.398&rep=rep1&type=pdf
[2] Mishkin, F. S. (1991) Asymmetric Information and Financial Crises: A Historical Perspective. In: Hubbard, R. G. (ed.) Financial Markets and Financial Crises. University of Chicago Press. Available from: https://www.nber.org/system/files/chapters/c11483/c11483
[3] Cowen, T. & Crampton, E. (2002) Market Failure or Success: The New Debate. Edward Elgar Publishing. Available from: https://www.e-elgar.com/shop/gbp/market-failure-or-success-9781843760252.html
[4] Barbaroux, P. (2014) From market failures to market opportunities: managing innovation under asymmetric information. J Innov Entrep. 3 (5). Available from: https://doi.org/10.1186/2192-5372-3-5
[5] Bloomenthal, A. (2020) Asymmetric Information. Available from: https://www.investopedia.com/terms/a/asymmetricinformation.asp [Accessed: 27th November 2020]
[6] Consumer Reports. (2020). Consumer Reports. Available from: https://www.consumerreports.org/cro/index.htm [Accessed: 29th November 2020]
[7] Bernheim, B. D. & Whinston, M. D. (2007) Microeconomics. Second Edition. McGraw-Hill Irwin. Available from: http://web.iitd.ac.in/~debasis/SUMMER_2012/ch1.pdf [Accessed: 28th November 2020]
[8] EconomicsHelp. (2020) Adverse selection explained. Available from: https://www.economicshelp.org/blog/glossary/adverse-selection/ [Accessed 29th November 2020]
[9] BBC News. (2016) The rise and rise of fake news. Available from: https://www.bbc.co.uk/news/blogs-trending-37846860 [Accessed 28th November 2020]
