Information failure means buyers or sellers lack accurate information, so decisions are made on guesses. The usual form is asymmetric information: one side knows more than the other.
This lesson belongs to market failure concepts. After public goods, it shows a failure that has nothing to do with externalities.
The market is not ignoring third parties. It is struggling with hidden quality.
What goes wrong, step by step?
- The seller knows the true quality. The buyer cannot check it before buying.
- The buyer is unsure, so is only willing to pay for the average quality.
- Sellers of above-average goods find the price too low and leave.
- The average quality of what remains falls, so the price buyers will pay falls again.
- The market shrinks, even though trade could have benefited both sides.
Real markets often have ways to reduce the problem, such as written warranties, inspection reports or independent ratings. A stated model may mention these as ways to share information. It is not asking you to judge whether they are enough.
Worked example: used scooters in Taman Rimba
Taman Rimba is a fictional town. A fictional dealer fair has 100 used scooters. Buyers cannot test them in detail.
| Type | Number | Worth to a buyer (RM) | Lowest price the seller accepts (RM) |
|---|---|---|---|
| Good | 60 | 4,000 | 3,500 |
| Faulty | 40 | 1,500 | 1,000 |
Step 1, average value if buyers cannot tell. (60 × 4,000 + 40 × 1,500) ÷ 100 = (240,000 + 60,000) ÷ 100 = RM 3,000.
Step 2, buyers’ offer. A buyer who cannot tell good from faulty will offer about RM 3,000.
Step 3, who stays? Good-scooter owners want at least RM 3,500. They refuse RM 3,000 and leave. Faulty-scooter owners accept, since RM 3,000 is above RM 1,000.
Step 4, buyers learn. If only faulty scooters are for sale, a buyer values them at RM 1,500, so the offer falls to about RM 1,500.
Step 5, result. The 60 good scooters are no longer traded, even though a buyer values each at RM 4,000 and the seller needs only RM 3,500. There was RM 500 of gain per scooter, so 60 × 500 = RM 30,000 of possible gain is lost.
The failure comes from hidden information, not from anyone being dishonest.
The mistake to watch for
Mistaken answer: “The market fails because the dealers are cheating buyers.”
The student has added a motive the model does not state. Information failure does not need cheating.
Correction: say that the buyer cannot verify quality and therefore bases the offer on the average. Sellers of good scooters withdraw, which lowers average quality. Stay with what the stated model says. Another slip is to say the price rises. Here the offer falls from RM 3,000 towards RM 1,500.
Check yourself
1. In a fictional market for 50 good laptops worth RM 3,000 and 50 poor ones worth RM 1,000 to a buyer, find the average value.
Show answer
(50 × 3,000 + 50 × 1,000) ÷ 100 = (150,000 + 50,000) ÷ 100 = RM 2,000.
2. If the sellers of good laptops each need at least RM 2,400, what happens?
Show answer
RM 2,000 is below RM 2,400, so the good-laptop sellers withdraw. Only poor laptops remain, which lowers the value buyers will offer towards RM 1,000.
3. Name one thing that could give buyers more information in this market, without saying whether it should be used.
Show answer
For example, a written inspection report or a warranty that lets buyers tell good from poor. Either one reduces the information gap.
Where this leads next
Next, bring the ideas of the whole module together in comparing modelled policy effects neutrally. The percentage-base explorer is useful for comparing losses as shares of value.
If you find yourself writing “because they are dishonest” in answers, a teacher in online one-to-one Economics tuition can help you replace guesses about motives with the model’s own evidence.