# Asymmetric Information in Economics Explained

> **Definition**
>
> Asymmetric information exists in the majority of transactions and typically benefits sellers of products and services more than buyers.

## What Is Asymmetric Information?

Asymmetric information, or the uneven amount or quality of material knowledge held by those engaged in a transaction, can spark innovation and support efficiency. It isn't necessarily used to the detriment of someone with less knowledge.

Asymmetric information typically manifests itself when the seller of a [good or service](https://www.investopedia.com/articles/economics/08/free-market-regulation.asp) possesses greater knowledge than the buyer. However, the reverse dynamic is also possible. Also known as "information failure," asymmetric information is involved in nearly all economic transactions.

### Key Takeaways

*   In certain transactions, sellers can take advantage of buyers due to asymmetric information, as the seller has more knowledge of the good being sold than the buyer.
*   The reverse can also be true: In some instances, a buyer can benefit from having a greater amount of information than the seller.
*   Asymmetric information can lead to market failures, such as inefficient market pricing and unfair economic results.
*   It can also lead to instances of fraudulent behavior.

![Asymmetic Information: When one party in a transaction possesses more information than the other.](https://www.investopedia.com/thmb/hd2aVME6u0vuUs9FY4x1N12CHUE=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/asymmetricinformation.asp-final-e712cba65fdf47c2834664a4007bb480.png)

*As a consequence, the party with less information faces higher risks in the transaction. — Investopedia / NoNo Flores*

## Understanding Asymmetric Information

The presence of asymmetric information usually exists in the case of the sale of an item. For example, if a homeowner wanted to sell their house, they would most likely have more information about the house than the buyer.

They might know some floorboards are creaky, the home gets too cold in winter, or that the neighbors are too loud—information that the buyer would not know until after they purchased the house. The buyer, then, might feel they paid too much for the house or would not have purchased it at all if they had been provided this information beforehand.

Asymmetric information can also be viewed as the specialization and division of knowledge, as applied to any economic trade.

For example, doctors typically know more about medical issues and practices than their patients. After all, physicians have extensive medical school educational backgrounds that their patients generally don't have.

This principle equally applies to architects, [teachers](https://www.investopedia.com/articles/personal-finance/112914/top-retirement-strategies-teachers.asp), police officers, attorneys, [engineers](https://www.investopedia.com/personal-finance/top-highest-paying-jobs/), fitness instructors, and other trained professionals. Asymmetric information, therefore, can be beneficial to an economy and a society because it can increase efficiency.

## Advantages and Disadvantages of Asymmetric Information

### Advantages

Asymmetric information isn't necessarily a bad thing. In fact, growing asymmetrical information is the desired outcome of a healthy [market economy](https://www.investopedia.com/terms/m/marketeconomy.asp).

As workers strive to become increasingly specialized in their chosen fields, they become more productive, and consequently can provide greater value to workers in other fields.

For example, a stockbroker's knowledge is valuable to a non-investment professional, such as a farmer, who may be interested in confidently investing in stocks to prepare for [retirement](https://www.investopedia.com/terms/r/retirement.asp).

On the flip side, the [stockbroker](https://www.investopedia.com/terms/s/stockbroker.asp) does not need to know how to grow crops or tend to livestock to feed themself, but rather can purchase items provided by the farmer from a grocery store.

In their respective trades, the farmer and the stockbroker hold superior knowledge over the other, but both benefit from each other's specialty and division of labor.

One alternative to ever-expanding asymmetric information is for workers to study all fields, rather than specialize in fields where they can provide the most value. However, this is an impractical solution, with high [opportunity costs](https://www.investopedia.com/terms/o/opportunitycost.asp) and potentially lower aggregate outputs, which would lower standards of living.

### Disadvantages

In some circumstances, asymmetric information may have nearly fraudulent consequences, such as [adverse selection](https://www.investopedia.com/terms/a/adverseselection.asp), which is a phenomenon where an insurance company encounters the probability of extreme loss due to a risk that was not divulged at the time of a policy's sale.

For example, if the insured hides the fact that they're a heavy smoker and frequently engage in dangerous recreational activities, this asymmetrical flow of information [constitutes adverse selection](https://www.investopedia.com/articles/insurance/082516/examples-adverse-selection-insurance-industry.asp). It could raise [insurance premiums](https://www.investopedia.com/terms/i/insurance-premium.asp) for all customers, forcing the healthy to withdraw.

The solution is for life insurance providers to perform thorough [actuarial](https://www.investopedia.com/articles/professionals/090513/day-life-actuary.asp) work and conduct detailed health screenings, and then charge different premiums to customers based on their honestly disclosed risk profiles.

> **Important**
>
> In certain asymmetric information models, one party can retaliate for contract breaches, while the other party cannot.

## Special Considerations

[To prevent abuse of customers](https://www.investopedia.com/ask/answers/050415/how-can-problem-asymmetric-information-be-overcome.asp) or clients by finance specialists, financial markets often rely on reputation mechanisms. Financial advisors and fund companies that prove to be the most honest and effective stewards of their client's assets tend to gain clients, while dishonest or ineffective agents tend to lose clients, face legal damages, or both.

The internet has reduced instances of unfavorable cases of asymmetric information because of the huge amount of data about a product or service that people can easily access and arm themselves with before they engage in a transaction.

## What Are the Two Problems That Arise From Asymmetric Information?

Two common problems can arise from asymmetric information: [moral hazard](https://www.investopedia.com/terms/m/moralhazard.asp) and adverse selection.

Moral hazard refers to situations in which one party's actions or behaviors change following a transaction. This might be seen in a homeowner who buys flood insurance and afterward ceases to take proactive measures to mitigate flood damage.

Adverse selection occurs when one party to a transaction seeks to benefit from asymmetric information. For instance, an individual might not disclose that they have an illness when applying for health insurance. This would obscure to the insurer the full potential risk of covering the individual.

## What Is the Market Failure When There Is Asymmetric Information?

Asymmetric information can lead to market failures. This is due to the fact that prices in markets are supposed to respond to demand and supply. When there is asymmetric information, buyers and sellers alike may distort pricing by withholding critical information about a product's quality or risk. This can then lead to economic outcomes that are unfair or inefficient allocations of resources.

## What Is the Meaning of Lemon Market?

In the context of markets, the [lemon](https://www.investopedia.com/terms/l/lemons-problem.asp) represents a problematic product whose true value is difficult to assess due to asymmetric information.

## The Bottom Line

Asymmetric information occurs in an economic transaction when one party has more knowledge than the other. This commonly occurs in commerce, where a seller has more information about product quality than a buyer.

Asymmetric information isn't always a bad thing, as it can represent specialization of the workforce. However, it can also give rise to situations where one party takes advantage over another.