Balance of Information

It is rare for the buyer and seller in a marketplace to know the same amount about the goods that they are exchanging. For example when I shop for a hotel room in a distant city I don’t know anything about hotel vacancy rates in that city while the hotel reservation system operator probably knows everything about that. Similarly when I buy a car I don’t know as much about the reliability of that car as the automaker.

This information imbalance creates large transaction costs since buyers are always nervous. That lowers the price they are willing to pay (since they have to be compensated for the risk they are taking) and causes them to delay their purchases. All that can increase substantially the desire of the seller to open up his books and operations so the seller can inspect them and assert that the seller is honest. Even if the seller isn’t willing to go that far he is likely to try and use PR and advertising to overcome this information gap.

Sometime we find intermediaries (middlemen again) popping up to fill the information gap. This is what Consumers Report does; or with less care the ‘journalists’ of a trades press. The “Good house Keeping Seal of Approval” is a nice example of a trade press rag evolving into a standards making body.

Standards are often (usually?) way to bridge the information gap. Even standard weights and measures function to allow a convient way for the buyer to know he’s at least getting a pound of tomatoes – even if he can’t tell if they are good or bad tomatoes. One of the roles the government plays is to run around and check that all the scales and pumps at grocery stores and gas stations are running right. Good and useful standards lower transaction costs and market participants are generally enthusiastic about having them well managed.

There are examples where the buyer knows more than the seller. This is not that uncommon on eBay for example where I might sell an old toaster with no knowledge what so ever if an old toaster is junk or a valuable collectible. In that enviroment expert buyers will sort it out. Ebay is thus an interesting example of a way to bridge is knowledge gap. Of course the seller still has to figure out how to get that pottery jug listed in the right catagory so that it will get noticed by the experts on early American pottery.

Some of my acquaintances who buy or sell a particular category of collectible on eBay tell me that there are typically communities of expert buyers and sellers in each domain. Interestingly they will self police the marketplace. Pointing out fraudulent listing and demanding the eBay clean them up. It’s a facinating example situation where the community members enforce the community standards that and thus make the market safer for nieve buyers and sellers.

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