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Imperfect Information

An important element of a competitive market is perfect information. By perfect information we mean that anything that may impact a buyer or seller's decision making process is known and understood. For example, in a perfectly competitive market for health insurance, providers would have full information on their clients' health status and charge premiums directly in relation to the their expected costs. However, our real world transactions often involve incorrect/incomplete information; in reality, individuals know a lot more about their own health than do potential insurers. This missing/incorrect information may lead to market failure because the party with better information has a competitive advantage. To further our understanding, we take a look at the health care insurance market and the used car market for a couple of examples of market failure caused by imperfect information. We will also look at how society may deal with informational asymmetries, and an interesting case study published in a recent The Economist magazine article.





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