What is Information Asymmetry?
Generated with ChatGPT
Two days ago, I placed an order for a phone and put up an older phone as an exchange. In the process of making the exchange, I had a rather interesting experience that perked up my public policy antennae.
While buying the phone, I had selected the older phone for which I got told that Iād get a value of about ā¹6,500. If I had the box etc, Iād be able to get about ā¹7,000 but I didnāt have the box on me so I settled for the discount of ā¹6,500.
It got delivered yesterday evening and the agent who had come, took the older phone, installed an app on it to run diagnostics. To set some context, this phone was used by an elder in my family who really cares for the phone and doesnāt drop itā/āmisuse itā/ācharges it well, etc. So I knew that there wouldnāt be any problems in it to find.
After a few minutes of running diagnostics, a white screen popped up and he showed me the screen claiming āSir, there is a discolouration in the screen, I will have to reduce ā¹1,000 from the exchange priceā. I tried looking for the discolouration but couldnāt notice anything and asked him where it was. A bit of back and forth trying to identify it, he said āSir, I am able to see it, but you cannot see itā, and thatās when my ears perked up. I responded asking him how I can take his word for it since I had no way to verify his claim and to me, it didnāt look discoloured whatsoever.
He paused for a minute, and then said āSir, if you pay me ā¹300, then I will pass this phone as fully OK and give you your original ā¹6,500 rate.ā
Iām sure you see the problem here š
The delivery person has access to tools and perhaps the training required to develop an eye to catch defects when picking phones up for exchanges. However, I have no access to these tools or to the skillset. This creates an imbalance between the two parties who are engaging in this transaction where one party has significantly more information than another.
The delivery person then clearly exploited this information gap by claiming something he knows I cannot verify. It puts one of the parties at an advantage and the other party is left either having to accept their word or challenge their claim without any evidence.
This, is what economists have termed Information Asymmetry. Because the information is asymmetrically available to the parties involved. Meaning that one party has more information than the other.
More often than not, this kind of a situation leads to a place where the one with more information calls the shots. Since their actions arenāt verifiable, they can choose to exploit this asymmetry and position of power in the transaction.
In my case, that was him asking for a bribe.
The next time I put up an old phone for exchange, I am going to be more cautious and Iām sure Iām not the only one that has experienced this. When information asymmetry is rampant in a marketplace, it will erode trust in the market (in this case the old phone exchange market). People might avoid even indulging in such transactions for fears similar to mine. As a result, before you know it, the entire marketplace might cease to exist, or might become toxic.
And that is why, Information Asymmetry is considered as a Market Failure. Because the market by itself failed to produce a fair and efficient outcome - one where the delivery person and I both have access to the same information and can both carry out a fair transaction.
As to what I did, I paid him the bribe (post negotiations), and completed the transaction. But for me to justify that, stay tuned for the next part where we cover another important economics concept - Opportunity cost!