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Imperfect Information as a form of Market Failure 

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           Imperfect information is a situation that occurs when either one or both parts of a transaction in the economy are not completely aware of all the features and qualities of the product they are selling or buying. The frequent and extensive existence of imperfect information can be a reason for the market failure that leads to a substantial welfare loss. Nonetheless, there are various ways in which the government can prevent the economy from the Pareto inefficient situation.
         In a perfect economy, both producers and consumers are supposed to have the excellent knowledge of the market. That includes the prices, costs, ingredients when it comes to specific products and other components that should be taken into account while executing a transaction from one party to another. However, that point of view is rather unrealistic as the information between the buyer and seller is hardly ever absolute. In most cases, the transactions are being processed under asymmetric information, which means that where people involved have an unequal amount of knowledge about the aspects of what is being sold or bought; some know more than the other.
          The first form of asymmetric information known as a problem of hidden action exists when somebody gets involved in a risky event bearing in mind the fact that he or she is under protection against the risk and the other party will incur the cost. A great evidence of how this situation may result in a market failure is provided by Michael Lewis (2010) in his book about the financial crisis caused by the United States housing bubble, based on true events that took place during the 2000s. In this case, there was no partition separating investment banking and commercial banking, which allowed previously stable traditional banks to invest in a nefarious mix of low-grade, high yield investments. The contributors were not perfectly aware of the risks introduced into the system by the banks, perhaps because many were international. That allowed American investment banks to foist off numerous high-risk pools of investments for liquidity, developing a stupendous bubble in the United States housing market. If there is one general statement to be made from this debacle, it is that the problem of moral hazard can result in dreadful consequences on the largest scale possible and moreover, wherever moral hazard occurs deceit tends to happen.
          The example of ‘Lemons’ given by George Akerlof, (1970) in his Nobel prize-winning paper demonstrates what are the effects of asymmetric information in this particular case. The customers, doubting the credibility of the owners of good and pricier cars, had an incentive to purchase the less expensive ones. That situation kept happening and cause the best vehicles to be outrun by the bad or average quality cars. As a result, buyers started to lower their expectations for any given car meaning that the average willingness to pay decreased. Those circumstances would encourage the owner of good cars not to sell and leave the market, which eventually would lead to a market failure. This instance is an example of hidden attributes, the problem that occurs when some characteristic of the person involved in an exchange is not known to other parties. As a repercussion of the aforementioned mechanism, markets might completely fail to prevail.
      The existence of imperfect information can be the reason for both buyers and sellers to refrain from taking interest in the market. Consumers might become discouraged because they cannot determine exactly the condition of a product. Sellers, on the other hand, might be hesitant to take part, because it is difficult to prove the quality of their goods to buyers and since consumers cannot determine which products have higher quality (as many times a buyer confronted with imperfect information will tend to believe that the price declares something about the quality of the product), they are unlikely to be willing to pay a higher price for such goods. When imperfect information is earnest, markets may become terribly thin since a comparatively very small number of participants attempt to exchange enough information that they can agree on a cost. 
         Even if the sellers establish the price accordingly to the quality of a product, the consumers, still keeping in mind the existence of imperfect information, may doubt its credibility. Therefore, the low cost might not be attractive to more buyers. Contrarily, a producer who increases prices may come across a greater success as the buyers might associate the bigger cost with a higher quality. This situation demonstrates how the issue of imperfect information can affect consumers’ decisions despite the sellers’ rational behaviour.
        In brief, the lack of complete, symmetric knowledge accompanying the transactions taking place in the economy results in the marginal social benefit being unequal to the marginal social cost, in other words, leads to a disequilibrium. The aforementioned situations of either undervaluation or overvaluation of a product are demonstrated by the following graphs:

 

Eck, P. and profile, V. 2017).
economicsblog online Pepijnvaneck.blogspot.com. 
Available at: http://pepijnvaneck.blogspot.com/2009/09/market-failure-occurs-when-free-markets.html 

    As it can be seen, the disequilibrium in both of these circumstances is causing a welfare loss, which creates a missing market – the one ‘in which there is some kind of exchange that, if implemented, would be mutually beneficial’. (The CORE Project)
     
        Although imperfect information is a serious issue for the economy, there are different policies that the government can make to intervene and address the market failure. A lot of them focus on increasing either the supply of information or the demand for it.
     First of all, the authorities may implement a more rigorous labelling policy to compel the producers to provide authentic information about the goods. For example, notifying about any type of toxicity a product may contain a proper sign. 
     Secondly, the government may impose safety standards and periodic inspections despite the lack of such demand from the consumer as the producers often use the fact that many buyers are unaware of the danger and safety risk related to a certain product. In extreme cases, a seller can be banned from marketing a good or service. 
     To avoid the problem of adverse selection in the financial capital market, a prospective borrower, before receiving a loan, should be required to provide the information about his income source as well as the guarantor who can commit himself to repaying the loan in a case when the original borrower is unable to pay back. Yet another approach presents the bank with the right to acquire for instance a property or equipment that it can, later on, seize and sell if the loan is not repaid.
     The fourth method preventing the effects of imperfect information is called occupational licensing. It is a way of assuring that workers with specific professions that require a wide range of skills are as a matter of fact authorised to pursue their job by completing a certain type of education or passing a test.
     Furthermore, government agencies should be required to make sure that citizens improve their financial and IT skills in order to become prudent consumers, able to make the right decisions. What is more, they should provide a decent education in the area of stimulating substances, as they are often a cause of severe health issues.
     Another action that would improve the economy is the implementation of warranties, guarantees, service contracts and refunds that act as a reassurance from sellers to buyers that their purchase is safe.
     Moreover, a consumer may have a right to sue or penalise a manufacturer that committed fraud by selling a defective product that caused a harm or injury to the buyer.
      The government may significantly improve the problem of imperfect information by regulating the advertising standards to make the commercials less coaxing and more informative.
      Additionally, there may be laws forcing the public limited companies to make their financial statements public as well as have them audited to reassure that their accounts are accurate.
      The government may also create a law that states that every vehicle owner has to have his or her car periodically checked by an authorised institution to make sure that the potential buyer can be presented with accurate information.
     In addition, the authorities should create more organisations with an objective to regulate and control the never-ending interactions in the economy to ensure that companies compete fairly and abide by the competition law. 
     To conclude, all that has been aforementioned undoubtedly proves that imperfect information is a form of market failure and demonstrates how immensely its existence affects the functioning of the economy. Undeniably, there is a lot that can be done and should be done by the government to continuously better the situation in the market. Fortunately, the contemporary world provides with a greater amount of knowledge, experience and technology than ever before and this fact makes the strive to attain the possibly closest state to equilibrium very promising. 

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