The Danger of Asymmetric Information

Sieun Yeom (Claire)

Imagine going to an all-you-caneat buffet where everyone pays the same price, regardless of how much they eat This may seem unfair to those who eat less, but from the restaurant’s perspective, it is difficult to charge different prices since they do not know who will eat more or less. This situation exemplifies asymmetric information, which occurs when one party in a transaction holds more information than the other, resulting in unfair benefits.

Asymmetric information is an imbalance of information between buyers(consumers) and sellers(producers) in a market that gives one side an unfair advantage in a transaction. When this happens, the market outcome will not be the most efficient, as the decisions are based on incomplete information From society’s point of view, asymmetric information leads to inefficient allocation of resources, either under allocation or overallocation to the production of products. Therefore, asymmetric information is seen as a market failure. In most cases, producers have more information than buyers making it difficult for buyers to make informed decisions However, in the case of an all-you-can-eat buffet, consumers are the ones who have more information than the sellers since they know much more about themselves, such as how much they can eat.

In such cases as an all-you-can-eat buffet, asymmetric information can lead to adverse selection, where one party exploits the information imbalance before the transaction occurs. Consumers in an all-you-can-eat buffet have more information about their appetites, making it easier for them to exploit the system by eating more than they usually would. This behavior is known as a moral hazard in which one participant takes on more risky behavior because they do not pay the consequences of that increased risk. A moral Hazard happens after the transaction has occurred. Since the buyers know they are freely available to have food, they tend to eat more than they usually would and throw away even more.

Due to the existence of asymmetric information, buyers and sellers of the market do not make decisions that maximize the welfare of the market, which leads to market failure. To address the adverse selection and moral hazard, governments can use legislation and regulation to reduce potential harms from asymmetric information For instance, laws and regulations can prevent market failure by addressing externalities, correcting market distortions, and promoting competition. In the context of an all-you-can-eat buffet, sellers can require the guests to finish their plates before serving more food or fine the guests according to the amount left behind

Buyers and Sellers can also use private responses such as signaling, the use of actions or attributes by a firm to convey information about its quality, intentions, or capabilities to its customers, investors, or other stakeholders This way, the guests will be less likely to present moral hazards since they will be more careful filling their plates and deciding how much they eat. Also, restaurants can set a time limit for customers to enjoy the food. Implementing time limits in a restaurant business can benefit the establishment financially by increasing table turnover, optimizing staffing levels, and potentially reducing the need for reservations, resulting in more efficient use of space and increased revenue. To manage sellers' asymmetric information, they can provide customers clear information about their food and the buffet's rules

The presence of asymmetric information in a transaction can pose significant risks for both buyers and sellers While certain situations, such as all-you-can-eat buffets, may present more difficult challenges in controlling information asymmetry, it is crucial to minimize this imbalance to prevent potential market failure

Bibliography

Kognity (no date) App Available at: https://app.kognity.com/study/app/y12-economics-hl/sid-186-cid167610/book/asymmetric-information-id-30498/ (Accessed: April 27, 2023).