Chapter 16: Problem 4

Why might it be difficult for a buyer and seller to agree on a price when imperfect information exists?

Short Answer

Expert verified

It is difficult for a buyer and seller to agree on a price when imperfect information exists because of asymmetry of information, perceived value discrepancies, the risk of adverse selection, and a lack of trust. This situation can lead to unfair negotiation advantages, exploited vulnerabilities, and different perceptions of the product's value. Additionally, the fear of adverse selection and a lack of trust can cause negotiation deadlocks, making it challenging for both parties to reach a mutually beneficial agreement.

Step by step solution

Understanding Imperfect Information

Imperfect information exists when the parties involved do not have the complete information about the product, its market value, or any other essential factor affecting the negotiation. This lack of information distorts their decision-making abilities, causing difficulties in agreeing on a price. As a result, they may not reach a fair and mutually beneficial agreement. \newline

Asymmetry of Information

One of the reasons for difficulties in agreeing on a price is the asymmetry of information, meaning that one party possesses more information about the product or market than the other. This can lead to unfair negotiation advantages or exploited vulnerabilities. The party with inferior information may feel uncertain and hesitant in reaching an agreement, fearing that they might be agreeing to an unfavorable deal. \newline

Perceived Value Discrepancies

When there's imperfect information, the buyer and seller may have different perceptions of the product's value. The buyer may undervalue the product due to concerns about hidden defects or a lack of knowledge about the market, while the seller may perceive a higher value based on factors not known or considered by the buyer. These discrepancies in perceived values make it difficult for both parties to agree on a price that satisfies both. \newline

Risk of Adverse Selection

Adverse selection is a phenomenon that occurs when one party, typically the buyer, suspects that the seller may be concealing negative information about the product. In this situation, the buyer might assume the worst-case scenario for the product's quality and thus be unwilling to agree on a higher price. The fear of adverse selection prevents both parties from reaching a price agreement, as the seller may feel that they cannot get a fair price for their product. \newline

Lack of Trust and Negotiation Difficulties

Imperfect information can also lead to a lack of trust between the buyer and the seller. The absence of transparency may create suspicion and make it difficult for both parties to compromise during negotiations. Distrust can also lead to negotiation deadlocks, making it almost impossible to agree on a price. \newline In conclusion, imperfect information creates uncertainties and discrepancies in perceived values, causing difficulties for buyers and sellers to agree on a price. It also contributes to the asymmetry of information, adverse selection, and a lack of trust, which further exacerbates the negotiation process.