What is asymmetric information?

Asymmetric information as a concept has probably existed for thousands of years, but it became mainstream in 2001 after Michael Spence, George Akerlof, and Joseph Stiglitz won the Nobel Prize in Economics for their work on information asymmetry in capital markets. Asymmetric information, otherwise known as information asymmetry, occurs when one party in a business transaction has access to more information than the other party.

DefinitionAsymmetric Information refers to a situation in which one party in a transaction possesses more or superior information than the other party. In economic and business contexts, this imbalance of information often occurs between buyers and sellers or between principals and agents. It can lead to adverse outcomes, such as market inefficiencies, moral hazards, and adverse selection. Asymmetric information can manifest in various forms, including hidden defects in products, undisclosed risks, or undisclosed financial information. The study of asymmetric information is central to understanding issues like market failures, insurance markets, and the role of intermediaries in reducing information disparities. Mitigating asymmetric information is crucial for promoting fair and efficient markets.
Key ConceptsInformation Disparity: Asymmetric information involves one party having more information than the other. – Market Inefficiencies: It can lead to market inefficiencies, such as suboptimal resource allocation. – Principal-Agent Problem: Asymmetric information often relates to the challenges of aligning the interests of principals and agents. – Adverse Selection: It can result in adverse selection, where one party takes advantage of the information gap. – Moral Hazard: Asymmetric information may lead to moral hazard, where one party’s behavior changes due to incomplete information.
CharacteristicsInformation Advantage: One party holds an advantage in terms of information quality or quantity. – Market Distortions: Asymmetric information can distort market outcomes and resource allocation. – Risk Assessment: It often relates to the assessment of risks and uncertainties. – Mitigation Mechanisms: Various mechanisms, such as signaling and screening, are used to address asymmetric information. – Insurance Markets: Asymmetric information is a key consideration in insurance markets.
ImplicationsMarket Inefficiency: Asymmetric information can lead to market inefficiencies and suboptimal resource allocation. – Risk Management: It affects risk assessment and risk management strategies. – Principal-Agent Challenges: Principals may face challenges aligning the interests of agents due to information disparities. – Insurance Challenges: Asymmetric information poses challenges in insurance markets, leading to issues like adverse selection. – Regulatory Interventions: Regulatory interventions and disclosure requirements may be necessary to address asymmetric information problems.
AdvantagesEfficient Resource Allocation: By addressing asymmetric information, markets can allocate resources more efficiently. – Risk Mitigation: Strategies like screening and signaling can help mitigate risks associated with information imbalances. – Improved Decision-Making: Parties with better information can make more informed decisions. – Market Functionality: Mitigating asymmetric information is essential for the proper functioning of markets. – Fairness: Reducing information disparities promotes fairness and trust in transactions.
DrawbacksComplexity: Mitigating asymmetric information can be complex and resource-intensive. – Regulatory Burden: Implementing regulations to address information disparities may impose burdens on businesses. – Incentives for Deception: Parties may have incentives to manipulate or hide information. – Noisy Signaling: Signals used to mitigate asymmetric information may not always be accurate or reliable. – Market Distortions: Overly aggressive measures to address asymmetric information can lead to market distortions.
ApplicationsUsed Car Sales: Asymmetric information is often observed in the sale of used cars, where sellers may have more information about a car’s condition. – Insurance Markets: Insurance markets heavily consider asymmetric information in underwriting and risk assessment. – Financial Services: Financial institutions use screening mechanisms to address information disparities in lending. – Healthcare: In healthcare, physicians often possess more information than patients, leading to asymmetric information challenges. – Investment Markets: Investors face information disparities when making investment decisions.
Use CasesUsed Car Purchase: When buying a used car, consumers may use vehicle history reports or independent inspections to mitigate information disparities. – Insurance Underwriting: Insurance companies use underwriting processes to assess risks associated with policyholders. – Lending Decisions: Financial institutions use credit scoring and financial information to assess borrowers’ creditworthiness. – Informed Consent in Healthcare: Healthcare providers inform patients about treatment options to address information disparities. – Investment Advisers: Investors may seek advice from financial advisers to bridge information gaps in investment decisions.

Understanding asymmetric information

In essence, the work showed that the financial sector – equipped with more knowledge, better networks, and proprietary information – tended to exploit retail market participants who in comparison were less knowledgeable, informed, and connected. The researchers found that this scenario was common in developing nations.

The committee responsible for awarding the prize also made mention of a report Akerlof had written over three decades earlier. His 1970 essay The Market For Lemons, the committee argued, was an invaluable study on the economics of information. The essay described the information asymmetry that occurs in the used car market where the seller possesses more information about the quality of the vehicle than the buyer. Far from being a mild inconvenience, Akerlof posited that information asymmetry had much broader implications and could impact capital markets and even cause market failures.

Three ways asymmetric information impacts business

How does asymmetric information impact business transactions, exactly? 

Let’s take a look:

Moral hazard

In the economic context, a moral hazard occurs when one party in the transaction takes on more risk because they will not experience the full consequences of that risk should a problem occur. The classic example of a moral hazard is a fund manager who invests their clients’ money. Some invest in riskier securities than if the capital was their own to invest, which causes an imbalance in information. Indeed, would the client approve of the investment if they had access to this knowledge? 

Monopoly of knowledge

Where only a few privileged individuals have access to the necessary information to make a decision. Knowledge monopolies are most associated with governments and other high-level organizations. Whatever the situation, however, the result of a knowledge monopoly is often a lower-level employee having to make a decision without access to the proper information.

Adverse selection

This occurs when the buyer and seller in a transaction have access to different information. However, it should be noted that the information the buyer holds is not necessarily superior to the information the seller holds, or vice versa. This form of information asymmetry, which is common in labor markets, retail markets, and even personal relationships, causes the buyer and seller to act based on the presumption that the other possesses the same information.

How can information asymmetry be avoided?

Information asymmetry is inherent to many industries and situations. As a result, strategies to avoid the phenomenon are as numerous as they are diverse.

With that in mind, we have listed a few general avoidance mechanisms below:

Provide more information

The simplest and most obvious solution is to provide more information. For the used car seller, this may involve not withholding the fact that the vehicle has a major engine fault that needs urgent attention.

Warranties and guarantees

Similarly, the used car buyer may elect to visit a business that specializes in second hand vehicles as opposed to purchasing from a private seller. This is because these businesses tend to offer warranties and other guarantees that compensate for any information asymmetry. 

Subsidies and taxes

In some healthcare markets, doctors benefit from information asymmetry by charging patients for medication or other services they do not actually need. In this case, governments often step in with heavier taxes on doctors or increased subsidies for patients.

Licensing and liability laws

These encompass consumer protection initiatives that force individuals to acquire the relevant licenses or permits before selling goods and services to buyers. Laws are also in place in most countries to protect the buyer in the case of scams, unfair treatment, and products that are otherwise unsafe, defective, or not as advertised.

Key takeaways:

  • Asymmetric information, otherwise known as information asymmetry, occurs when one party in a business transaction has access to more information than the other party.
  • Asymmetric information has three main impacts on business. These include moral hazards, knowledge monopolies, and adverse selections.
  • Asymmetric information is inherent in most industries and can never be eliminated completely. The best way to avoid it is simple: provide more information! Other strategies involve warranties, guarantees, subsidies, taxes, and legal protection.

Key Highlights

  • Origin and Significance: The concept of asymmetric information gained prominence in 2001 after Michael Spence, George Akerlof, and Joseph Stiglitz won the Nobel Prize in Economics for their work on information asymmetry in capital markets. Asymmetric information occurs when one party in a business transaction possesses more information than the other party.
  • Understanding Asymmetric Information: This phenomenon became well-known through research showing that the financial sector often exploits retail market participants due to differences in knowledge, networks, and information. Akerlof’s 1970 essay “The Market For Lemons” highlighted information asymmetry’s broader implications, including potential impacts on capital markets and market failures.
  • Impacts on Business:
    • Moral Hazard: One party may take on more risk when they won’t fully bear the consequences of that risk, as seen with fund managers investing clients’ money more aggressively.
    • Monopoly of Knowledge: Only a few privileged individuals possess crucial information, leading to decisions made without proper access to information.
    • Adverse Selection: Buyers and sellers in a transaction have differing information, leading them to act based on presumed equal knowledge.
  • Avoidance Mechanisms:
    • Provide More Information: Offering more information to counter information asymmetry is a straightforward solution.
    • Warranties and Guarantees: Businesses can offer warranties and guarantees to compensate for information asymmetry, as seen in used car sales.
    • Subsidies and Taxes: Governments may implement subsidies for patients or taxes on professionals to counteract information asymmetry in sectors like healthcare.
    • Licensing and Liability Laws: Licensing and legal regulations require sellers to provide accurate information, protect buyers, and ensure fair practices.

Connected Economic Concepts

Market Economy

The idea of a market economy first came from classical economists, including David Ricardo, Jean-Baptiste Say, and Adam Smith. All three of these economists were advocates for a free market. They argued that the “invisible hand” of market incentives and profit motives were more efficient in guiding economic decisions to prosperity than strict government planning.

Positive and Normative Economics

Positive economics is concerned with describing and explaining economic phenomena; it is based on facts and empirical evidence. Normative economics, on the other hand, is concerned with making judgments about what “should be” done. It contains value judgments and recommendations about how the economy should be.


When there is an increased price of goods and services over a long period, it is called inflation. In these times, currency shows less potential to buy products and services. Thus, general prices of goods and services increase. Consequently, decreases in the purchasing power of currency is called inflation. 

Asymmetric Information

Asymmetric information as a concept has probably existed for thousands of years, but it became mainstream in 2001 after Michael Spence, George Akerlof, and Joseph Stiglitz won the Nobel Prize in Economics for their work on information asymmetry in capital markets. Asymmetric information, otherwise known as information asymmetry, occurs when one party in a business transaction has access to more information than the other party.


Autarky comes from the Greek words autos (self)and arkein (to suffice) and in essence, describes a general state of self-sufficiency. However, the term is most commonly used to describe the economic system of a nation that can operate without support from the economic systems of other nations. Autarky, therefore, is an economic system characterized by self-sufficiency and limited trade with international partners.

Demand-Side Economics

Demand side economics refers to a belief that economic growth and full employment are driven by the demand for products and services.

Supply-Side Economics

Supply side economics is a macroeconomic theory that posits that production or supply is the main driver of economic growth.

Creative Destruction

Creative destruction was first described by Austrian economist Joseph Schumpeter in 1942, who suggested that capital was never stationary and constantly evolving. To describe this process, Schumpeter defined creative destruction as the “process of industrial mutation that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one.” Therefore, creative destruction is the replacing of long-standing practices or procedures with more innovative, disruptive practices in capitalist markets.

Happiness Economics

Happiness economics seeks to relate economic decisions to wider measures of individual welfare than traditional measures which focus on income and wealth. Happiness economics, therefore, is the formal study of the relationship between individual satisfaction, employment, and wealth.


An oligopsony is a market form characterized by the presence of only a small number of buyers. These buyers have market power and can lower the price of a good or service because of a lack of competition. In other words, the seller loses its bargaining power because it is unable to find a buyer outside of the oligopsony that is willing to pay a better price.

Animal Spirits

The term “animal spirits” is derived from the Latin spiritus animalis, loosely translated as “the breath that awakens the human mind”. As far back as 300 B.C., animal spirits were used to explain psychological phenomena such as hysterias and manias. Animal spirits also appeared in literature where they exemplified qualities such as exuberance, gaiety, and courage.  Thus, the term “animal spirits” is used to describe how people arrive at financial decisions during periods of economic stress or uncertainty.

State Capitalism

State capitalism is an economic system where business and commercial activity is controlled by the state through state-owned enterprises. In a state capitalist environment, the government is the principal actor. It takes an active role in the formation, regulation, and subsidization of businesses to divert capital to state-appointed bureaucrats. In effect, the government uses capital to further its political ambitions or strengthen its leverage on the international stage.

Boom And Bust Cycle

The boom and bust cycle describes the alternating periods of economic growth and decline common in many capitalist economies. The boom and bust cycle is a phrase used to describe the fluctuations in an economy in which there is persistent expansion and contraction. Expansion is associated with prosperity, while the contraction is associated with either a recession or a depression.

Paradox of Thrift

The paradox of thrift was popularised by British economist John Maynard Keynes and is a central component of Keynesian economics. Proponents of Keynesian economics believe the proper response to a recession is more spending, more risk-taking, and less saving. They also believe that spending, otherwise known as consumption, drives economic growth. The paradox of thrift, therefore, is an economic theory arguing that personal savings are a net drag on the economy during a recession.

Circular Flow Model

In simplistic terms, the circular flow model describes the mutually beneficial exchange of money between the two most vital parts of an economy: households, firms and how money moves between them. The circular flow model describes money as it moves through various aspects of society in a cyclical process.

Trade Deficit

Trade deficits occur when a country’s imports outweigh its exports over a specific period. Experts also refer to this as a negative balance of trade. Most of the time, trade balances are calculated based on a variety of different categories.

Market Types

A market type is a way a given group of consumers and producers interact, based on the context determined by the readiness of consumers to understand the product, the complexity of the product; how big is the existing market and how much it can potentially expand in the future.

Rational Choice Theory

Rational choice theory states that an individual uses rational calculations to make rational choices that are most in line with their personal preferences. Rational choice theory refers to a set of guidelines that explain economic and social behavior. The theory has two underlying assumptions, which are completeness (individuals have access to a set of alternatives among they can equally choose) and transitivity.

Conflict Theory

Conflict theory argues that due to competition for limited resources, society is in a perpetual state of conflict.

Peer-to-Peer Economy

The peer-to-peer (P2P) economy is one where buyers and sellers interact directly without the need for an intermediary third party or other business. The peer-to-peer economy is a business model where two individuals buy and sell products and services directly. In a peer-to-peer company, the seller has the ability to create the product or offer the service themselves.


The term “knowledge economy” was first coined in the 1960s by Peter Drucker. The management consultant used the term to describe a shift from traditional economies, where there was a reliance on unskilled labor and primary production, to economies reliant on service industries and jobs requiring more thinking and data analysis. The knowledge economy is a system of consumption and production based on knowledge-intensive activities that contribute to scientific and technical innovation.

Command Economy

In a command economy, the government controls the economy through various commands, laws, and national goals which are used to coordinate complex social and economic systems. In other words, a social or political hierarchy determines what is produced, how it is produced, and how it is distributed. Therefore, the command economy is one in which the government controls all major aspects of the economy and economic production.

Labor Unions

How do you protect your rights as a worker? Who is there to help defend you against unfair and unjust work conditions? Both of these questions have an answer, and it’s a solution that many are familiar with. The answer is a labor union. From construction to teaching, there are labor unions out there for just about any field of work.

Bottom of The Pyramid

The bottom of the pyramid is a term describing the largest and poorest global socio-economic group. Franklin D. Roosevelt first used the bottom of the pyramid (BOP) in a 1932 public address during the Great Depression. Roosevelt noted that – when talking about the ‘forgotten man:’ “these unhappy times call for the building of plans that rest upon the forgotten, the unorganized but the indispensable units of economic power.. that build from the bottom up and not from the top down, that put their faith once more in the forgotten man at the bottom of the economic pyramid.”


Glocalization is a portmanteau of the words “globalization” and “localization.” It is a concept that describes a globally developed and distributed product or service that is also adjusted to be suitable for sale in the local market. With the rise of the digital economy, brands now can go global by building a local footprint.

Market Fragmentation

Market fragmentation is most commonly seen in growing markets, which fragment and break away from the parent market to become self-sustaining markets with different products and services. Market fragmentation is a concept suggesting that all markets are diverse and fragment into distinct customer groups over time.

L-Shaped Recovery

The L-shaped recovery refers to an economy that declines steeply and then flatlines with weak or no growth. On a graph plotting GDP against time, this precipitous fall combined with a long period of stagnation looks like the letter “L”. The L-shaped recovery is sometimes called an L-shaped recession because the economy does not return to trend line growth.  The L-shaped recovery, therefore, is a recession shape used by economists to describe different types of recessions and their subsequent recoveries. In an L-shaped recovery, the economy is characterized by a severe recession with high unemployment and near-zero economic growth.

Comparative Advantage

Comparative advantage was first described by political economist David Ricardo in his book Principles of Political Economy and Taxation. Ricardo used his theory to argue against Great Britain’s protectionist laws which restricted the import of wheat from 1815 to 1846.  Comparative advantage occurs when a country can produce a good or service for a lower opportunity cost than another country.

Easterlin Paradox

The Easterlin paradox was first described by then professor of economics at the University of Pennsylvania Richard Easterlin. In the 1970s, Easterlin found that despite the American economy experiencing growth over the previous few decades, the average level of happiness seen in American citizens remained the same. He called this the Easterlin paradox, where income and happiness correlate with each other until a certain point is reached after at least ten years or so. After this point, income and happiness levels are not significantly related. The Easterlin paradox states that happiness is positively correlated with income, but only to a certain extent.

Economies of Scale

In Economics, Economies of Scale is a theory for which, as companies grow, they gain cost advantages. More precisely, companies manage to benefit from these cost advantages as they grow, due to increased efficiency in production. Thus, as companies scale and increase production, a subsequent decrease in the costs associated with it will help the organization scale further.

Diseconomies of Scale

In Economics, a Diseconomy of Scale happens when a company has grown so large that its costs per unit will start to increase. Thus, losing the benefits of scale. That can happen due to several factors arising as a company scales. From coordination issues to management inefficiencies and lack of proper communication flows.

Economies of Scope

An economy of scope means that the production of one good reduces the cost of producing some other related good. This means the unit cost to produce a product will decline as the variety of manufactured products increases. Importantly, the manufactured products must be related in some way.

Price Sensitivity

Price sensitivity can be explained using the price elasticity of demand, a concept in economics that measures the variation in product demand as the price of the product itself varies. In consumer behavior, price sensitivity describes and measures fluctuations in product demand as the price of that product changes.

Network Effects

In a negative network effect as the network grows in usage or scale, the value of the platform might shrink. In platform business models network effects help the platform become more valuable for the next user joining. In negative network effects (congestion or pollution) reduce the value of the platform for the next user joining. 

Negative Network Effects

In a negative network effect as the network grows in usage or scale, the value of the platform might shrink. In platform business models network effects help the platform become more valuable for the next user joining. In negative network effects (congestion or pollution) reduce the value of the platform for the next user joining. 

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