Asymmetric information exists when one side of a transaction has better or more relevant information than the other side.
Why it matters
Markets often rely on prices and contracts to coordinate behavior. When buyers, sellers, borrowers, lenders, workers, or insurers know different things, prices alone may not produce efficient outcomes.
Two classic problems
- Adverse selection: hidden information before the contract, such as when riskier buyers are more likely to seek insurance.
- Moral hazard: hidden actions after the contract, such as when insured parties take less care because the insurer bears part of the loss.
Economic consequences
Asymmetric information can cause lower trade volume, worse contract terms, rationing, or complete market breakdown. That is why screening, signalling, collateral, monitoring, and reputation play such large roles in real economies.
Related Terms
Knowledge Check
### Asymmetric information means:
- [x] one side of a transaction knows more relevant information than the other
- [ ] all market participants know exactly the same thing
- [ ] prices never matter
- [ ] contracts are unnecessary
> **Explanation:** The problem is unequal information, not the total absence of information.
### Adverse selection occurs mainly:
- [x] before a contract is signed
- [ ] after all actions are perfectly observed
- [ ] only in government budgeting
- [ ] only in national accounting
> **Explanation:** It arises from hidden information known before agreement.
### Why do signalling and screening matter?
- [x] They help reduce the inefficiencies caused by unequal information
- [ ] They eliminate all uncertainty permanently
- [ ] They make contracts obsolete
- [ ] They are unrelated to market performance
> **Explanation:** These mechanisms help reveal hidden information and improve contract design.