Asymmetric Information
Information is, of course, a valuable commodity, and markets for
information and expertise are well developed, as every student is aware.
Markets for expertise are conceptually identical to markets for any other
valuable service. They can pose special problems, however. One of these
we have already discussed: Information is often a public good and, when
it is, it tends to be underproduced by a free market.
Even when information is not a public good, markets for expertise are
prone to market failure. The reason is that one party to a transaction can
often take advantage of special knowledge in ways that change the nature
of the transaction itself. Situations in which one party to a transaction has
special knowledge are called situations of asymmetric information
The importance of asymmetric information to the operation of the
economy has received considerable attention in recent years. In 2001,
Professors George Akerlof, Michael Spence, and Joseph Stiglitz shared the
Nobel Prize in economics for their insights about how asymmetric
information can lead to market failures. The two important sources of
market failure that arise from situations of asymmetric information are
moral hazard and adverse selection.
Moral Hazard