Key Concepts and Summary

Key Concepts and Summary

Many economic transactions are made in a situation of imperfect information, where either the buyer, the seller, or both are less than 100% certain about the qualities of what is being bought and sold. When information about the quality of products is highly imperfect, it may be difficult for a market to exist.

A “lemon” is the name given to a product that turns out, after the purchase, to have low quality. When the seller has more accurate information about the quality of the product than the buyer, the buyer will be hesitant to buy, out of fear of purchasing a “lemon.”

Markets have many ways to deal with imperfect information. In goods markets, buyers facing imperfect information about products may depend upon money-back guarantees, warranties, service contracts, and reputation. In labor markets, employers facing imperfect information about potential employees may turn to resumes, recommendations, occupational licenses for certain jobs, and employment for trial periods. In capital markets, lenders facing imperfect information about borrowers may require detailed loan applications and credit checks, cosigners, and collateral.

Glossary

asymmetric information

a situation where the seller or the buyer has more information than the other regarding the quality of the item being sold

collateral

something valuable—often property or equipment—that a lender would have a right to seize and sell if the loan is not repaid

cosigner

another person or firm who legally pledges to repay some or all of the money on a loan if the original borrower does not do so

imperfect information

a situation where either the buyer or the seller, or both, are uncertain about the qualities of what is being bought and sold

money-back guarantee

a promise that the buyer’s money will be refunded under certain conditions

occupational license

licenses issued by government agencies, which indicate that a worker has completed a certain type of education or passed a certain test

service contract

the buyer pays an extra amount and the seller agrees to fix anything specified in the contract that goes wrong for a set time period

warranty

a promise to fix or replace the good for a certain period of time