Unit 1 Micro: Information Failure

Information is a crucial concept in AS micro economics and in this blog we bring together some key definitions related to information issues and also some of the recent blogs and revision presentations on information economics

What is information failure?

Information failure occurs when people have inaccurate, incomplete, uncertain or misunderstood data and so make potentially ‘wrong’ choices. From pensions to computer games consoles, from investing in the stock market to ignorance about the consequences of borrowing and debt, all of us suffer from one or more information failures.

The key issue to evaluate is whether the information failure is trivial or whether it has a huge effect on individuals, their families and society as a whole. There may well be a case for the government to intervene in the market if information failures become serious.

Examples of information failure

Imperfect information can be caused by

Misunderstanding the true costs or benefits of a product: E.g. the social costs and benefits of different classes of drugs and the private and social benefits from higher education when there are so many universities and courses to choose from.

Uncertainty about costs and benefits e.g. should younger workers be buying into pension schemes when we can only guess at economic conditions in 40 years time?

Complex information for example choosing between makes of computers requires specialist knowledge of hardware. Do I buy an Apple or PC computer? Consider too the problems of choosing a quality second hand car or when deciding whether or not to buy a property.

Inaccurate or misleading information e.g. persuasive advertising may ‘oversell’ the benefits of a product leading to more consumption than is optimal. Spam mail can be a cause of misinformation for consumers. Read this Tim Harford article on spam!

Addiction e.g. drug addicts may be unable to stop consumption of harmful substances

Lack of awareness – a good example here is that of tuition fees in Britain. The Coalition Government has introduced a new system of tuition fees for universities in the UK, but many parents and students claim to find the fee system mystifying and feel they have not received enough information about it. A public information campaign seems to have made little impact. Many students say that they are not fully aware of the charges and get little information from universities on the careers prospects and future earnings of their graduates after they have moved into the labour market.

Key Terms on Information Failures

Adverse selection: Where the expected value of a transaction is known more accurately by the buyer or the seller due to an asymmetry of information; e.g. health insurance

Asymmetric information: Occurs when somebody knows more than somebody else in the market. Such asymmetric information can make it difficult for the two people to do business together. A situation in which some agents have more information than others and this affects the outcome of a bargain between them

De-merit good: The consumption of de-merit goods can lead to negative externalities which causes a fall in social welfare. The government normally seeks to reduce consumption of de-merit goods. Consumers may be unaware of the negative externalities that these goods create - they have imperfect information.

Information failure: Information failure occurs when people have inaccurate, incomplete, uncertain or misunderstood data and so make potentially ‘wrong’ choices.

Moral hazard: When people take actions that increase social costs because they are insured against private loss: sometimes it is called hidden action due to the agent’s actions being hidden from the principal

Information Failure and Government Intervention

* Consumer awareness campaigns
* Compulsory labelling of products (e.g. nutrition)
* Consumer rights protection laws
* Warranties as a signal of quality / reliability
* Bans on short-selling in financial markets
* Social media and customer feedback
* Importance of seller-reputation e.g. eBaY and Trip Advisor - but beware problems with this!
* Professional body accreditation schemes
* Minimum cooling-off periods when purchasing
* In extreme examples, outright bans