He implications of asymmetric information for the function of markets Essay

He implications of asymmetric information for the function of markets at both the microeconomic and macroeconomic levels - Essay Example The situation where the market produces more or less than the ideal or the optimal amount of a particular good, it is regarded as the market failure in terms of economics There are several factors that results in the market failure like externalities and monopoly power, and asymmetric information.Еhe implications of asymmetric information for the function of markets at both the microeconomic and macroeconomic levels.In an analysis of the competitive market structure it is always assumed that the buyers and the sellers have perfect knowledge about the market. But in reality this does not happens. When the available information about any product is more with someone than the others then the arisen situation is of market failure and the phenomenon is termed as â€Å"asymmetric information†. The information about the product is an important factor and if the quality of the goods could be judged about whether it being excellent or inferior then the price would have adjusted acc ording to the quality differences. Asymmetry and Market failure and the need of the government intervention A. Market failure and the used car market The situation of information asymmetry leading to market failure is best understood by the example of used cars. In a transaction of a used car, a seller would always know more than the buyer. Considering a case of a second hand Chevrolet Malibu which would cost $15,000 in an ‘average’ condition, if the condition of the car is ‘excellent’, that would cost $18,000 and if the condition of the car is ‘poor’, the car will be priced at $12,000.... without any excellent car will be ready to pay not more than $13500 that is the average price of the cars, which are either in average or poor condition. This in turn will prevent the average car owners from offering their car at such a low price. So at the end the market forces will adjust itself to equilibrium for the poor cars at the selling price of $12000. This is an example of market failure where the market for the excellent and average cars does not exist due to the asymmetry of information. This is a situation of quality uncertainties where the high quality goods are driven out by the low quality goods. (Chauhan, n. d, pp. 224-225) This is explained with the help of a diagram: PH SH P E P’ E’ DH DH’ DH† 0 Q’ Q Figure 1 (a) PL p’ e' SL p e DL’ DL 0 q q’ Figure 1(b) Source: Chauhan, n. d, pp. 224-225 In the diagram Figure 1 (a) DH represents the demand for high quality goods, SH, the supply for high quality goods. They int ersect at the point E where the quantity OQ must be demanded and it must be supplied at OP price. Due to the asymmetry of information, the same amount OQ is demanded at a lower price E†. As the buyers are uncertain about the quality of the product they treat the high quality good as the low quality good and hence the demand curve shifts downwards to DH’. At this lower price some of the seller refuses to sell the product which causes the supply to fall from OQ to OQ’. Hence the new equilibrium is at E’, where the DH’ intersects S H. The OQ amount of high quality goods is sold at a price OP’.As there exists quality uncertainty the demand curve is expected to further slide down to DH† which does not intersect with the supply curve SH at all. This shows how the market for high quality goods fails. In the figure 1(b),