Information symmetry

Information symmetry is the state in which relevant business information, such as about a security on the foreign exchange market, is readily available and in the possession of all those involved in a transaction. Involved parties may be persons or organizations. In a more general sense, it means all parties involved have all the necessary information at the same time. It is the opposite of information asymmetry. Most economic models and theories are based on information symmetry, or perfect information. However, some economists take a less traditional approach by considering the effects of imperfect information. During the 1970s and 1980s, several influential economists examined the markets with the assumption that one party involved in most transactions had better information than the other.

Background

Many economists of the late twentieth century focused on symmetric and asymmetric information theory. For example, in economist George Akerlof’s 1970 paper, “The Market for ‘Lemons’: Quality Uncertainty and the Market Mechanism,” he asserts that buyers and sellers of newer-model, used cars have asymmetric information. The paper’s title comes from bad cars, which are often called lemons. The sellers are motivated to sell goods that may be of poor quality. However, the buyer does not have the same information about the cars. Lemons and high-quality cars look the same. For this reason, sellers of good cars cannot get better than average market price for their vehicles. Buyers and sellers perceive the value of the goods differently. This lemon problem can be seen in the consumer and business marketplaces and in investing.

The lemon problem demonstrates the consequences of asymmetrical information. The buyer does not know the good cars from the bad and, therefore, does not know the true value of the vehicles. The buyer may be willing to pay only an average price. While this sounds like a logical choice, the buyer is, in fact, paying too much if the car is a lemon, but only the seller has this information. The seller has an advantage and benefits from such a sale because the average price is more than the value of the car. On the other hand, because the buyer is unwilling to pay a premium price for a car for fear of buying a lemon, the seller of a high-quality vehicle is at a disadvantage. The seller may have to settle for little or no profit by selling the quality car at a lower price—or not selling it at all. This is because the potential sale price is affected by the customer’s fear of getting a lemon due to the asymmetry of information.

In 1973, economist Michael Spence wrote the paper “Job Market Signaling.” He viewed employees in much the same way Akerlof approached cars. He wrote that the quality of a particular good or service was unknown to the buyer. An employer evaluates an applicant but is unsure of how productive the employee will be. Hiring, according to Spence, is like playing the lottery. Information asymmetries between employees and employers lead to income depression because employers are wary of paying more in wages if they are unsure of the outcome.

Economist Joseph E. Stiglitz also addressed asymmetric information in regard to the insurance markets. Insurers know far less about the risk of insuring a client than the customer knows. This causes insurance companies to raise all premiums, often preventing low-risk customers from achieving the policies they want. In theory, information symmetry would allow insurers to offer policies that were balanced based on individual risks. Akerlof, Spence, and Stiglitz shared the 2001 Nobel Prize for their work on the impact of asymmetric information on markets.

Overview

Many economists have said that, in theory, asymmetric information causes market failure. If the theories are correct, the opposite should be true—symmetric information causes market stability or equilibrium. When he proposed the lemon problem, Akerlof suggested one way to counter it was to provide strong warranties. If a buyer was assured of a way to overcome the negative experience of buying a lemon, the buyer should be more willing to pay a higher-than-average rate. In the decades that followed, another possibility emerged: technology.

The information explosion that has resulted from the widespread use of the Internet has put more information in the hands of consumers than at any time in human history. While information symmetry is an ideal that may not often be purely realized, consumers can often come close.

As an example, Akerlof’s lemon problem is significantly less risky with the advent of information services such as Carfax. Consumers making other purchases can peruse information on websites such as Angi or publications such as Consumer Reports. Investors and traders also have a wealth of information at their fingertips. They may subscribe to Bloomberg Professional service, which delivers a wealth of information directly to their computer terminals.

Spence also proposed a solution to create information symmetry in the hiring process. He suggested employees, who know more about their productivity than a potential employer, could signal their skills through the information they provide about education. Having completed a four-year college degree, Spence said, was an indication that an individual is skilled at learning. While this is not altogether true—an individual could simply be good at paying tuition on time and complete minimal work to graduate—signaling is an important part of human behavior. Humans make conscious choices, such as clothing, car, and degrees to pursue and earn. Such choices tell others something about them.

In addition to signaling, another potential means of approaching information symmetry is screening. In a number of papers, Stiglitz suggested that insurance companies could allow customers to self-sort themselves into risk categories by offering insurance options covering a range of premiums and deductibles. Healthy customers would prefer low-premium, high-deductible policies, while unhealthy customers would gravitate toward high-premium, low-deductible policies.

Bibliography

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Chen, James. “The Problem of Lemons: Buyer vs. Seller.” Investopedia, 13 Feb. 2024, www.investopedia.com/terms/l/lemons-problem.asp. Accessed 19 Dec. 2024.

Henderson, David R. “George A. Akerlof 1940–.” The Library of Economics and Liberty, www.econlib.org/library/Enc/bios/Akerlof.html. Accessed 19 Dec. 2024.

Henderson, David R. “Joseph E. Stiglitz 1943–.” The Library of Economics and Liberty, www.econlib.org/library/Enc/bios/Stiglitz.html. Accessed 19 Dec. 2024.

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Ross, Sean. “Theory of Asymmetric Information Definition & Challenges.” Investopedia, 13 May 2024, www.investopedia.com/ask/answers/042415/what-theory-asymmetric-information-economics.asp. Accessed 19 Dec. 2024.

Spread, Patrick. Economics for an Information Age: Money-Bargaining, Support-Bargaining and the Information Interface. Routledge, 2018.