A Level Economics AQA Practice Exam

What is a consequence of asymmetric information in the market?

1. Equal bargaining power for all parties

2. Market inefficiencies and potential exploitation

3. Enhanced competition among firms

4. Full transparency in pricing

The correct answer is: Market inefficiencies and potential exploitation

Asymmetric information occurs when one party in a transaction has more or better information than the other party. This imbalance can lead to various market consequences. When one party has more information, it can result in market inefficiencies, as individuals or businesses may make suboptimal decisions based on the information they have. For example, a seller might know the true quality of a product while the buyer does not. If the buyer cannot accurately assess the product's value, they may either overpay or underpay. This can lead to a situation known as "adverse selection," where only lower-quality products are offered in the market, as high-quality sellers withdraw from the market due to the inability to signal their product quality effectively. Additionally, the party with superior information may exploit their advantage. For example, they might charge higher prices knowing the other party is unaware of the true value of the good or service. This exploitation can further distort market dynamics and lead to less fair and efficient outcomes. Overall, the presence of asymmetric information often results in detrimental effects on market performance, contributing to inefficiencies and opportunities for exploitation. This makes the identification of such consequences crucial for understanding how markets operate and the importance of transparency for achieving more equitable trading conditions.