EPFL Logo
fr|en
Login
Concept

Information asymmetry

In contract theory and economics, information asymmetry deals with the study of decisions in transactions where one party has more or better information than the other. Information asymmetry creates an imbalance of power in transactions, which can sometimes cause the transactions to be inefficient, causing market failure in the worst case. Examples of this problem are adverse selection, moral hazard, and monopolies of knowledge. A common way to visualise information asymmetry is with a scale, with one side being the seller and the other the buyer. When the seller has more or better information, the transaction will more likely occur in the seller's favour ("the balance of power has shifted to the seller"). An example of this could be when a used car is sold, the seller is likely to have a much better understanding of the car's condition and hence its market value than the buyer, who can only estimate the market value based on the information provided by the seller and their own assessment of the vehicle. The balance of power can, however, also be in the hands of the buyer. When buying health insurance, the buyer is not always required to provide full details of future health risks. By not providing this information to the insurance company, the buyer will pay the same premium as someone much less likely to require a payout in the future. The adjacent image illustrates the balance of power between two agents when there is Perfect information. Perfect information means that all parties have complete knowledge. If the buyer has more information, the power to manipulate the transaction will be represented by the scale leaning towards the buyer's side. Information asymmetry extends to non-economic behaviour. Private firms have better information than regulators about the actions that they would take in the absence of regulation, and the effectiveness of a regulation may be undermined. International relations theory has recognized that wars may be caused by asymmetric information and that "Most of the great wars of the modern era resulted from leaders miscalculating their prospects for victory".

Official source
About this result
This page is automatically generated and may contain information that is not correct, complete, up-to-date, or relevant to your search query. The same applies to every other page on this website. Please make sure to verify the information with EPFL's official sources.
Related courses (21)
FIN-608: Information and Asset Pricing
We study the role of information in equilibrium asset pricing models. We cover simple one-period models of incomplete and asymmetric information using competitive rational expectation equilibria and B
MGT-431: Information: strategy & economics
Introduction to the economics of information and its strategic ramifications. The main objectives are to use economic theory to understand strategic interactions in the presence of uncertainty, estima
COM-309: Introduction to quantum information processing
Information is processed in physical devices. In the quantum regime the concept of classical bit is replaced by the quantum bit. We introduce quantum principles, and then quantum communications, key d
Show more
Related publications (32)
Show more
Related concepts (18)
Contract
A contract is an agreement that specifies certain legally enforceable rights and obligations pertaining to two or more mutually agreeing parties. A contract typically involves the transfer of goods, services, money, or a promise to transfer any of those at a future date. In the event of a breach of contract, the injured party may seek judicial remedies such as damages or rescission. A binding agreement between actors in international law is known as a treaty.
The Market for Lemons
"The Market for 'Lemons': Quality Uncertainty and the Market Mechanism" is a widely cited seminal paper in the field of economics which explores the concept of asymmetric information in markets. The paper was written in 1970 by George Akerlof and published in the Quarterly Journal of Economics. The paper's findings have since been applied to many other types of markets. However, Akerlof's research focused solely on the market for used cars.
Contract theory
From a legal point of view, a contract is an institutional arrangement for the way in which resources flow, which defines the various relationships between the parties to a transaction or limits the rights and obligations of the parties. From an economic perspective, contract theory studies how economic actors can and do construct contractual arrangements, generally in the presence of information asymmetry. Because of its connections with both agency and incentives, contract theory is often categorized within a field known as law and economics.
Show more

Copyright © 2025 EPFL, all rights reserved

Graph Chatbot

Chat with Graph Search

Ask any question about EPFL courses, lectures, exercises, research, news, etc. or try the example questions below.

DISCLAIMER: The Graph Chatbot is not programmed to provide explicit or categorical answers to your questions. Rather, it transforms your questions into API requests that are distributed across the various IT services officially administered by EPFL. Its purpose is solely to collect and recommend relevant references to content that you can explore to help you answer your questions.