Asymmetric Information - Explained
What is Asymmetric Information?
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Table of ContentsWhat is Asymmetric Information?How is Asymmetric Information Used?Economic Advantages of AsymmetricDisadvantages of Asymmetric InformationInformation Asymmetry in Finance
What is Asymmetric Information?
Asymmetric information refers to a situation in a contractual agreement or economic transaction where the two parties involved have disproportionate information. Restated, when one party has greater information and material knowledge than the other party in a contract, asymmetric information occurs.
Asymmetric information is otherwise called information failure or imbalance of information. It is often common in transactions between buyers and sellers where the seller has higher information or knowledge about the product than the buyer. It is also possible for the buyer to have greater material knowledge than the seller.
How is Asymmetric Information Used?
Asymmetric information can be applied to any form of trade or transaction, in fact, it is said that all economic transactions feature asymmetric information. Inequality in the information possesses by parties in a contract or the presence of lopsided information causes asymmetric information.
Asymmetric information occurs in diverse types of trade relationships, even in medicine. For instance, a doctor, nurse or pharmacist often has greater information about medical practices and products than patients.
Also, in a construction contract, an architect or an estate planner possesses greater knowledge than the owner of a piece of land.
Economic Advantages of Asymmetric
Despite that asymmetric information is attributed to information imbalance and unequal knowledge between parties in an economic transaction or contract, it has some benefits. Most healthy markets and economy desire asymmetric information was given the following benefits;
- It results in increasing knowledge between experts in specialized fields. For instance, medical doctors, pharmacists, architects, teachers and other professionals always strive to be at the top of their game by having greater knowledge.
- Asymmetric information enhances the productivity of professionals and experts in certain fields because they see their clients as being reliant on them.
Disadvantages of Asymmetric Information
Asymmetric information is not without some disadvantages, the major ones include the following;
- Asymmetric information can lead to inefficiencies in certain markets, especially if the inequality or gap between the information that both parties possess is too much.
- Imbalance information can also cause fraudulent tendencies in the market, given that some professionals use the extra information they possess about the transaction to milk extra penny from the other party.
- Asymmetric information leads to the abuse of the party with less information by the one who has greater information.
- In insurance, asymmetric information can lead to adverse selection, especially, if the policyholder hides certain information from the insurer.
Information Asymmetry in Finance
Asymmetric information abounds in the finance world, this is when finance experts possess greater material knowledge than clients. Given the unequal information possessed by the financial advisor and the customers, customers tend to seek advice from the experts.
In order to limit the abuse of customers by financial advisors and experts, it is essential that information about the financial world is made available. Also, financial advisors are expected to act in utmost good faith when transacting, they must also act in the best interest of their clients.
One major solution to information asymmetry in finance is the abundance of financial information that individuals can access via the internet and other publications and data sources.