Information asymmetry
[13] They later awarded another Nobel Prize in 2001 to George Akerlof, Michael Spence, and Joseph E. Stiglitz for their "analyses of markets with asymmetric information".
[citation needed] Greek Stoics (2nd century BCE) treated the advantage that sellers derive from privileged information in the story of the Merchant of Rhodes.
Joseph Stiglitz considered the work of earlier economists, including Adam Smith, John Stuart Mill, and Max Weber.
[17] These three economists helped to further clarify a variety of economic puzzles at the time and would go on to win a Nobel Prize in 2001 for their contributions to the field.
[16] He was the first to coin the term "signaling",[16] and encouraged other economists to follow in his footsteps because he believed he had introduced an important concept in economics.
In this paper, Akerlof introduced a fundamental concept that certain sellers of used cars have more knowledge than the buyers, and this can lead to what is known as "adverse selection".
Stiglitz expanded upon the ideas of Spence and Akerlof by introducing an economic function of information asymmetry called "screening".
[13] In 1996, a Nobel Prize was given to James Mirrlees and William Vickrey for their research back in the 1970s and 1970s on incentive problems when facing uncertainty under asymmetric information.
Differing from the topics presented by Akerlof, Spence and Stiglitz, Mirrlees and Vickrey focused on how income taxation and auctions can be used as a mechanism to draw out information from market participants efficiently.
[20] Akerlof continues to champion behavioral economics, that these breaches into the fields of psychology and sociology are profound extensions of information asymmetry.
[4] In adverse selection models, the ignorant party lacks or has differing information while negotiating an agreed understanding of or contract to the transaction.
An example of monopolies of knowledge is that in some enterprises, only high-level management can fully access the corporate information provided by a third party.
The classic paper on adverse selection is George Akerlof's "The Market for Lemons" from 1970, which brought informational issues to the forefront of economic theory.
For example, sellers with better information than buyers include used-car salespeople, mortgage brokers and loan originators, financial institutions and real estate agents.
Due to this, healthy policyholders are incentivized to leave and reapply to get a cheaper policy that matches their expected health costs, which causes the premiums to increase.
Other market mechanisms that help reduce the imbalance in information include brand names, chains and franchising that guarantee the buyer a threshold quality level.
Warranties are utilised as a method of verifying the credibility of a product and are a guarantee issued by the seller promising to replace or repair the good should the quality not be sufficient.
Product warranties are often requested from buying parties or financial lenders and have been used as a form of mediation dating back to the Babylonian era.
For example, the Securities and Exchange Commission (SEC) initiated Regulation Fair Disclosure (RFD) so that companies must faithfully disclose material information to investors.
Firstly, media outlets, due to their ownership structure or political influences, may fail to disseminate certain viewpoints or choose to engage in propaganda campaigns.
Lastly, mass surveillance helps the political and industrial leaders to amass large volumes of information, which is typically not shared with the rest of society.
Likewise, in finance literature, the acknowledgment of information asymmetry between organizations challenged the Modigliani–Miller theorem, which states that the valuation of a firm is unaffected by its financial structure.
[50] Various measures are used to align interest of managers to stop them from abusing their power from information asymmetry such as compensating based on performance using a bonus structure.
[55] Contract theory provides insights into how various economic agents can enter contractual arrangements in situation of unequal levels of information.
For instance, in a road construction contract, a civil engineer may have more information on the various inputs required to undertake the project, than the other parties.
Through contract theory, economic agents gain insights on how they can exploit information available to them, to enter beneficial contractual arrangements.
[59] A 2013 study by Schmidt and Keil has revealed that the presence of private information asymmetry within firms influences normal business activities.
[63] An example of this is executives announcing a stock repurchase plan without any intention of carrying it out, allowing them to raise new cash flow for their own benefit at the expense of shareholders.
The nature of the internet and prevalence of social media in society has given firms opportunities to create promotional content in a less passive way than other forms of advertising.
[65] Some consumers are aware of the usage of strategies and techniques by firms to advertise and influence their media consumption, however do not necessarily alter their trust in the source of the information accordingly.
