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MENTAL MODEL · M4662

Information Asymmetry

Information Asymmetry
BusinessHigh supportMicroeconomics
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Version 1.0.0 · Updated 2026-07-30

CORE DEFINITION

A situation in which the two parties to a transaction have different levels of information about the subject of the transaction, with one party having more or more accurate information than the other. This can lead to market failures such as adverse selection and moral hazard.

SCAFFOLDING EFFECT

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A key issue in market design. It explains why there may be a "lemon problem" in the used car market and why insurance companies need to design different policies. Mechanisms to address information asymmetry include signaling, screening, reputation systems, and third-party certification.

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One party to a transaction has information that the other does not (e.g., the seller knows quality, the buyer knows preferences). Asymmetry before the transaction leads to adverse selection (lemon market: bad money drives out good); asymmetry after the transaction leads to moral hazard (negligence after insurance). The market may fail or be inefficiently allocated as a result. The goal of mechanism design is to reduce asymmetry through signaling, screening, reputation, and certification.

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Source support: Explicit

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    en.wikipedia.orghttps://en.wikipedia.org/wiki/Information_asymmetryZH · Explicit
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