Information failure

Question 1

Why is perfect information important

Answer 1

Consumers and firms need to be aware of the costs and benefits associated with producing and consuming the product for allocative efficiency to occur in a market

Question 2

Why does imperfect information occur

Answer 2

1) irrational consumers
2) Asymmetric information

Question 3

What are the solutions to asymmetric information

Answer 3

• requirements from businesses to get accreditation
• firms to disclose terms and conditions properly
• ‘cooling off’ periods for financial transactions so people can think more calmly and carefully about decisions

Question 4

Explain the asymmetric information example involving second hand cars ie lemons and cherries

Answer 4

• For example, lemons are worth 2000 and cherries are worth 10000
• Because of asymmetric info, lemon sellers can also sell their cars for 10000 because consumers cant tell the difference
• assuming equal number of lemons and cherries, consumers are willing to pay (0.5x10000)+(0.5x2000) = 6000
• This drives cherries out of the market as consumers are underpaying out of fear of overpaying for a lemon
• This causes a missing market of good quality second hand cars

Question 5

What is the solution to the lemon problem

Answer 5

• Inspections of quality/ quality assurance tests
• only cherries would offer warranties