1. Chapter 4A Information Failures
Another type of market failure occurs when either buyers or sellers have incomplete or inaccurate information and the cost of obtaining better information is prohibitive.
Information Failures
Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

2. Inadequate Buyer Information
Asymmetric information
Unequal knowledge possessed by the parties to a transaction
Buyer has inadequate information on sellers
Underallocation of resources
Better information too costly
Government corrects with inspections, laws against illegal advertising, licensing
Asymmetric information is a source of potential market failure, causing society’s scarce resources to be allocated inefficiently. A potential party to a transaction may withdraw from the market due to fear of being exploited because he or she lacks information.
LO6

3. Inadequate Seller Information
Moral hazard problem
One party alters behavior after contract is signed that is costly to other party
Sellers have inadequate information on buyers
Underallocation of resources
May promote outcome it is trying to prevent
Auto insurance, unemployment compensation, athletes guaranteed contracts
A person who buys insurance may willingly incur more risk.
LO6

4. Inadequate Seller Information
Adverse selection problem
Second party incurs major costs due to lack of information
Occurs when the contract is signed
Those most in need of insurance will be those who purchase it
Prevents pooling of high and low risks
Social security system prevents this
Information know by the first party to a transaction is not known by the second party and the second party incurs a cost as a result. An example of this would be a life insurance company that offers a life insurance policy and advertises “no medical exam necessary” would attract those who have life-threatening diseases. The social security program, designed to insure against poverty in one’s old age, makes almost everyone participate creating a pool of both high and low risk individuals.
LO6

5. Qualifications Ways to overcome information difficulties
Consumers may buy product warranties
Franchises provide uniform products or services
Private firms can provide information
Consumer reports, travel guides, credit reports
The private sector can overcome some information problems by offering warrantees for products, no hassle return policies, and through publications that rate a product worthiness. Internet sites, like Facebook and Angie’s List, can be used as a source of finding information about different products and service providers.
LO6