This is a situation where there is imperfect knowledge. In particular it occurs where one party has different information to another. A good example is when selling a car, the owner is likely to have full knowledge about its service history and likelihood to break down. The potential buyer, by contrast, will be in the dark and he may not be able to trust the car salesman.
Asymmetric information in financial markets
Asymmetric information is a problem in financial markets such as borrowing and lending. In these markets the borrower has much better information about his financial state than the lender. The lender has difficulty knowing whether it is likely the borrower will default. To some extent the lender will try to overcome this by looking at past credit history and evidence of salary. However, this only gives a limited information. The consequence is that lenders will charge higher rates to compensate for the risk. If there was perfect information, banks wouldn’t need to charge this risk premium.Asymmetric information in insurance
Another example of asymmetric information is with regard to insurance. When insuring a good the insurer is uncertain how well the customer will look after a piece of property. For example, if a consumer was careless with locking his bike, the insurer would not want to insure it. This problem can lead to the related problem of adverse selection.To overcome asymmetric information in insurance, insurers will give big discounts for ‘no claims bonuses’ this is the best way of gaining better information about ‘careful’ and ‘unlucky’ consumers
Asymmetric information can also be analysed with game theory. For example, when deciding whether to cut or increase prices, firms will be uncertain about how their rivals will behave and react. They will have to make decisions whilst trying to second guess how other firms will respond.
Source: Economics Help
