You’re off to buy a new-to-you vehicle. I believe they like to call them “pre-owned” these days because it’s supposed to sound better than used (“used” has the connotation of being abused). Anyway, you go to your local used-car lot. What’s the first thing the sales dude asks? “How much you lookin’ to spend?” What is he really asking? He basically wants to see your demand curve. Whatever you do, don’t show it to him. He’s asking what’s the “maximum you are willing to pay?” Why? Because he wants to capture as much of your consumer surplus as possible.
It’s all about value. The higher the price you pay, the more money the sales guy makes. If you pay the highest you are willing to pay, there’s no extra value for you. It’s the same as with the monopoly – the more value they can extract through a higher price, the less surplus the consumer gets to keep.
The problem is that you have a willingness to pay for a car that will give you some value. How do you really know that the car is as valuable as you think? It might have a dodgy carburetor, or the fuel pump might be shot. Or worse, the engine could be ready to blow. The salesman has more information than you do. This will be especially true if it’s a private sale and you don’t even have the extra guarantee, or extended warranty.
When one party has more or different information about a good or service, we call it information asymmetry. If you pay $3,000 for the car you’re looking at, and it turns out that it requires $1,000 in repairs that you didn’t expect, you didn’t get what you paid for. Another way to say it is that your marginal cost doesn’t equal the marginal benefit. Unless marginal cost equals the marginal benefit, the outcome is inefficient.
Let’s look specifically at agriculture. Do the seeds always perform as promised? Does the equipment always work the way it’s supposed to? Perhaps you’re in the cattle business and the expensive bull you just purchased isn’t at peak performance and can only be used for bologna.
There are many cases of information asymmetry in agriculture, some of which are studied by the professors in our department. Professor Jill Hobbs is an expert in supply chain management and does research on traceability. How do we know our food is safe; especially foods that come from other countries with lower health and safety standards? If you buy frozen vegetables for example and it’s been contaminated by listeria, you will become incredibly ill, and you could even die! This cost is not accounted for in the price, and you don’t have the knowledge to prevent your illness. It’s pretty safe to say that this is a case of market failure as a result of information asymmetry.
Where else would you find information asymmetry in the market?
Food labelling is another issue that falls into this category. Consumers increasingly demand more labelling and want to know exactly what is in the food that they eat not only for health reasons, but because they value environmental and social sustainability.
Consider agroforestry products – were the building products you are purchasing made from trees harvested using sustainable practices that didn’t degrade the ecosystem? What about meat products? Many people want to know they are consuming animal protein where the animals were treated humanely. It’s difficult to tell whether the animal was treated properly or not when you’re viewing two steaks side-by-side unless you have some other type of assurance. The list goes one – free-range eggs (from allegedly happy chickens), omega-enhanced eggs, hormone-free beef, products without additives, gluten-free products, peanut-free foods, GMO ingredients, etc.
What is the solution to the asymmetry problem? Information. How do we require more information? While a company’s goodwill (e.g. the possibility to return a good if you don’t like it even if it was used by you) can go a long way, in many cases we require government intervention. This is how governments can improve upon market solutions as we discussed in Module 1.
There are full disclosure laws for real estate, for example. If you buy a house and the former owners didn’t tell you that the basement floods every spring, and they knew it, they will be held liable and you can seek compensation. In the US, if you buy a new car that turns out to have serious problems, you can get your money back (the US legislation regarding cars is referred to as the “lemon” law.).
In agriculture, there is increasingly more pressure to add information to labels about animal welfare, ingredients, additives, etc. There are also requirements that allow industry to track the origin of an animal to be able to contain infectious diseases such as bovine spongiform encephalopathy (BSE) in cattle, or swine flu in cattle. There is also a debate about labelling GMO foods – to what extent do they need to be labelled?
While all of this seems like a great idea, it requires a trade-off: the greater the requirements for labelling and traceability, including requirements that allow producers and/or consumers to track foods through the supply chain, the greater the costs. Costs are passed down to consumers as greater prices. Therefore, if we value this information, we will pay for it.
We should also think about what we’re getting "at the margin." We all want safe food, right? Of course, we do. Do we think our food is safe now? The answer might depend on who you are and what you value. If you think food is already safe enough, then making food “safer” – i.e., taking steps to increase food safety by a little bit might not be worth it to you. Others might be willing to pay much more to ensure contamination cases are reduced each year, even by a small fraction. Something for you to consider and discuss.
One way we as a society try to combat information asymmetry is through the Canadian Food Inspection Agency (CFIA) and social media (see the Tweet from CFIA below). You can even sign up to follow food recalls in cases where foods have been contaminated, or you can click on the links below to go to Twitter. Alternatively, go directly to the CFIA Food recall warnings.
Figure 8-4: CFIA tracking to improve upon information asymmetry. Source: Twitter. Permission: This material has been reproduced in accordance with the University of Saskatchewan interpretation of Sec.30.04 of the Copyright Act.