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Homework answers / question archive / Why can asymmetric information between buyers and sellers lead to market failure when a market is otherwise perfectly competitive? A
Why can asymmetric information between buyers and sellers lead to market failure when a market is otherwise perfectly competitive?
A. If the buyer and seller have different information about the transaction, the price will not reflect either the average benefit to the buyer or the marginal cost to the seller.
B. If the market would otherwise be perfectly competitive, then asymmetric information will not result in a market failure because price is equal to marginal cost.
C. If the buyer and seller have different information about the transaction, the price will not reflect either the marginal benefit to the buyer or the marginal cost to the seller.
D. If the market would otherwise be perfectly competitive, then asymmetric information will result in a market failure only if the market collapses.
C_ is correct.
It is because asymmetric information causes the problem of adverse selection where the buyers and the sellers do not have the proper information, so the marginal benefit and the marginal cost cannot be determined.
Explanations of incorrect options:
_A_ is incorrect.
It is because when the buyer and the seller have different information, the price will not reflect the average benefit; instead, it will reflect the marginal benefit.
_B_ is incorrect.
It is because even if the market is perfectly competitive, asymmetric information will always lead to market failure.
_D_ is incorrect.
It is because when the market is perfectly competitive asymmetric information will always result in a market failure.
