EconPort - Asymmetric Information

In the Health Insurance Market, buyers know more information about their own health problems than do potential insurance providers. With this better information, buyers have an incentive to conceal their health problems in attempt to get a lower insurance premium. In other words, if insurance providers knew that a person had a history of heart problems, insurance providers could charge him or her a higher rate. This informational disparity is often referred to as asymmetric information.

Asymmetric information is a cause of market failure in many different arenas. One of the most commonly used examples is used and new cars. Although a new car may be worth $25,000 and then the seller wishes to sell it almost immediately after purchase the value drops drastically. This is because buyers are wary that something may be wrong with the car even though the seller just decided they didn't want it anymore. In this case, the seller of the car has more information than the buyer and the buyer has to trust the seller to tell them all of the pertinent information in relation to the car.

The insurance market and the used cars are just some examples of how asymmetric information affects the economy and causes market failure. The real estate market is another example in which the seller has more information than the potential buyer. In this case, it is the previous homeowner as well as the real estate agent who knows the most about the house or property in question.

There are two basic models that describe information asymmetry and they are:

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