Imperfect and asymmetric information

Symmetric and asymmetric information

• Symmetric information: buyers and sellers have the same information about a product.
• Asymmetric information: one side of the transaction knows more than the other. Usually the seller knows more (a used car dealer knows the car's faults), but sometimes the buyer does (a person buying insurance knows their own health and habits better than the insurer).

Imperfect information more generally means people lack the information to make the best decision, for example about long-term effects of their choices.

Why information gaps matter

When consumers misjudge the benefits or costs of a good, their demand does not reflect its true value, so the market quantity is wrong:

• people under-consume goods whose benefits they underestimate (for example education or preventive healthcare)
• people over-consume goods whose harms they underestimate (for example tobacco or high-sugar foods)
• sellers with better information may charge high prices or sell poor-quality products, and good-quality sellers may leave the market because buyers will not pay for quality they cannot check.

The four markets in the specification

• Healthcare: patients rely on doctors to tell them what treatment they need. A doctor paid per treatment might recommend more than necessary; patients may not seek treatment they need because they do not know its value.
• Education: students and parents may underestimate the long-term benefits of education because they happen years later, so too little is consumed. They may also struggle to judge the quality of different schools or courses.
• Pensions: saving for retirement means comparing complex products and predicting needs decades ahead; many people save too little or choose products with high charges they do not understand.
• Insurance: buyers know their own risk better than insurers (asymmetric information). If insurers charge an average premium, low-risk people may not buy, leaving mainly high-risk customers, which pushes premiums up (adverse selection). After buying, people may also take less care (moral hazard, next lesson).

Possible responses (topic 1.3.6): information provision, regulation, compulsory labelling, state provision.

Worked example

Explain how asymmetric information can lead to market failure in the market for second-hand cars.

1. Sellers know whether their car is reliable; buyers cannot easily tell.
2. Buyers are only willing to pay a price reflecting average quality.
3. Owners of good cars find this price too low and withdraw from the market, so the average quality of cars on sale falls.
4. Fewer good cars are traded than would be with full information: resources are misallocated.

Answer: Buyers cannot judge quality, so good cars are under-traded and bad cars dominate: market failure.

Check yourself

1. Asymmetric information exists when
   • buyers and sellers have exactly the same information
   • one party to a transaction has more information than the other
   • the government sets the price
   • goods are non-rival
   Show answer

   one party to a transaction has more information than the other. The information is unequal.

2. A patient cannot judge whether a recommended operation is necessary. This is an example of
   • a public good
   • a positive production externality
   • symmetric information
   • asymmetric information in healthcare
   Show answer

   asymmetric information in healthcare. The doctor knows much more than the patient.

3. Why might young people under-consume education in a free market?
   • Education is a free good
   • They may underestimate the long-term benefits, which come years later
   • Education is non-excludable
   • Education has no private benefit
   Show answer

   They may underestimate the long-term benefits, which come years later. Benefits that arrive in the future are easily undervalued.

4. Many people save too little for retirement. Which explanation is linked to imperfect information?
   • Pensions are public goods
   • Pensions are perfectly price elastic
   • Pension products are complex and people cannot easily judge how much they will need
   • Pensions create external costs of production
   Show answer

   Pension products are complex and people cannot easily judge how much they will need. Complexity and long time horizons make good decisions hard.

5. An insurer cannot tell which customers are high risk, so it charges everyone the same premium. Which is the most likely result?
   • Low-risk customers drop out and premiums rise
   • Only low-risk customers buy insurance
   • Premiums fall for everyone
   • The insurer has perfect information
   Show answer

   Low-risk customers drop out and premiums rise. The average premium is poor value for low-risk people, so the pool becomes riskier (adverse selection).

6. Explain how imperfect information can lead to the over-consumption of a good.
   Show answer

   If consumers do not know or underestimate the harmful effects of a good, such as the health damage from tobacco, their demand is higher than it would be with full information, so more is consumed than the socially optimal amount.. Information gap, then the effect on demand, then the comparison with the optimum.

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Sources

• Pearson Edexcel International Advanced Subsidiary/Advanced Level in Economics specification (2018)

Last updated 8 November 2026. Spotted a mistake? Tell us.