Study notes

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 or currency markets to ignorance about the consequences of borrowing and debt, all of us suffer from one or more information failures.

The key issue is whether the information failure is trivial or whether it has a big effect on individuals, their families and society as a whole.

There may well be a case for the government to intervene in the market in some way if information failures become serious.

Examples of information failure

Health Dangers from Processed Meats

Sausages, ham, bacon and other processed meats appear to increase the risk of dying young, a study of half a million people across Europe suggests. It concluded diets high in processed meats were linked to cardiovascular disease, cancer and early deaths. The researchers, writing in the journal BMC Medicine, said salt and chemicals used to preserve the meat may damage health.

Adapted from news reports, April 2013

Imperfect information can be caused by
  • Misunderstanding the true costs or benefits of a product: E.g. the side effects of using tanning salons or painkillers
  • Uncertainty about costs and benefits e.g. should younger workers be buying into pension schemes when we can only guess at conditions in 40 years time?
  • Complex information when buying specialist products
  • Inaccurate or misleading information - 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.
  • 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 – many parents and students find the system of university finance difficult to understand

Asymmetric Information

For markets to work, there needs to be symmetric information i.e. consumers and producers have the same level of knowledge about the products, and they know everything there is to know about them and the effects of consuming them?

Asymmetric information occurs when somebody knows more than somebody else in the market. This can make it difficult for the two people to do business together.

Examples include:

  1. Landlords who know more about their properties than tenants for example student tenants looking to rent some digs
  2. Mortgages: A borrower knows more about their ability to repay a loan than the lender, insufficient checks might be made
  3. Car insurance companies who cannot tell the risks associated with selling premiums to each single driver – they have to pool risks
  4. Some students have superior knowledge about how to get into the elite / best universities including which prior courses to take
  5. Doctors have superior knowledge about which drugs and treatments to recommend to their patients
  6. A used-car seller knows more about vehicle quality than a buyer - this gives rise to the problem of the Market for Lemons
  7. Insider information of traders in financial markets
  8. Information advantages for high-frequency stock market traders
Asymmetric Information
Asymmetric Information
The used car market is an oft-quoted example of information failures making it difficult for consumers to make purchases

Government intervention aimed at closing the information gap

Tackling Binge Drinking

The Scottish government sees cut-price drink as a major factor in widespread abuse of alcohol that results in huge social and health costs. It has introduced legislation to bring in a minimum retail price for alcohol in supermarkets of 50 pence per unit.

Often market failure results from consumers suffering from a lack of information about the costs and benefits of the products available in the market place. Government action can have a role in improving information to help consumers and producers value the 'true' cost and/or benefit of a good or service. Examples might include:
  • Compulsory labelling on cigarette packages with health warnings to reduce smoking
  • Improved nutritional information on foods to counter the risks of growing obesity
  • Anti-speeding television advertising to reduce road accidents and advertising campaigns to raise awareness of the risks of drink-driving
  • Information campaigns on the dangers of smoking addiction and binge-drinking
  • Businesses in England and Wales that allow under-18s to use sun beds can now be fined up to £2,000. The Sunbed (Regulation) Act 2010 stops young people using sun beds in places including salons, gyms and hotels
  • Consumer protection laws e.g. right for refunds of faulty goods
  • Industry standards / guarantees for selling used products such as second hand cars

These programmes are really designed to change the "perceived" costs and benefits of consumption for the consumer. They don't have any direct effect on market prices, but they seek to influence "demand" and therefore output and consumption in the long run. Increasingly adverts are becoming more hard-hitting in a bid to have an effect on consumers.

Information failure - tanning salons and the long term dangers about tanning

Extreme Sun Damage - Nicola Roberts: The Truth About Tanning - Preview
Extreme Sun Damage - Nicola Roberts: The Truth About Tanning - Preview

Tim Harford tries to buy a second hand car!

Tim Harford - The Undercover Economist
Tim Harford - The Undercover Economist

Insider Trading

Insider trading is when a person makes a stock trade after learning material, non-public information about the company

Short video clip on insider trading
Short video clip on insider trading

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