Tuesday, May 09, 2006

Asymmetrical Information

I was listening to NPR's MarketPlace (which is a wonderful program that I don't get to listen to that often as it airs at 6.30PM which means I have to leave work early and that doesnt happen too often). Anyways, in yesterday's program, there was a segment about used cars.

In that show, the cheekily called "Undercover Economist" Tim Harford explained why it is that its difficult to buy a good used car. His logic was simple: People who have good cars and want to sell it cant find a good price for it as there is no way for them to prove that their car is good and they are being honest about the car's condition. And hence they end up keeping it. So, guess what ends up in the market - lemons. Apparently this theory, called as Asymmetrical Information Theory was first explained by George Akerlof, an economist in his 1970 paper titled, The Market for Lemons.

I was both intrigued and fascinated by this theory and it explains a lot of things that I see in the world. Asymmetric Information is everywhere. Buyer knows less information about the goods than the seller of a used car. An employer knows less about the person he's about to hire than the actual person himself and hence the lemons that you see at your work place. You see it in the internet. A website knows less about an user visiting the site than the user himself. (See Freakonomics)

Anyways, it's an interesting theory and you can see this theory being in use everywhere. I wonder if there are any solutions on how to solve (or reduce) this information asymmetry.

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