Usually, a lot of media coverage is about the disadvantages of the digital revolution, such as privacy issues, monopolistic tendencies or (non-)taxation of international service providers.
The coverage is for a good reason. This blog is also focusing on the downsides. As well as on the upsides.
A key question of ‘Making Sense of the Digital Age’ is: What are the structural advantages of the digital economy?And how can we all benefit from the digital change?
Today we look at what economics call information asymmetries.
For instance, customers often don’t have detailed information on a product or a service. This can be for many reasons: customers might not be interested in details, or pieces of information are hidden by the sellers.
Information asymmetries are an important matter in economics. They reduce welfare. It happens if the price paid exceeds the subjective value of a good or service.
Usually, buyers don’t do that. They don’t buy things with lower benefits than the money they have spent. It’s irrational. But it occurs whenever a product or service falls short of the buyer’s expectations. If the buyer thought something was more valuable than it turned out to be, he or she was misled.
The ‘Theory of Asymmetric Information’ (you’ll find more there) is about this mistake.
Some brief notes on the theory:
- The ‘Theory of Asymmetric Information’ was developed in the 1970s and 1980s as a plausible explanation for market failures.
- Market failure, to economists, means an inefficient distribution of goods and services in a free market, in which the law of supply and demand determines prices.
- Three economists were particularly influential in developing and writing about the theory of asymmetric information: George Akerlof, Michael Spence, and Joseph Stiglitz. The three shared the Nobel Prize in economics in 2001 for their contributions.
- The key insight of the theory: Asymmetric information leads to poor quality because buyers can’t identify good quality. Therefore, they search for the best price. Prices are just a simple purchasing criterion.
Akerlof focused on the low-quality insight in a 1970 paper entitled “The Market for ‘Lemons’: Quality Uncertainty and the Market Mechanism.”
Akerlof uses the colloquial term lemons to refer to bad cars, and he argues that buyers often do not have all the information to distinguish a lemon from a good car. Thus, sellers of good cars cannot get better-than-average market prices for their products. As a result, the quality of goods and services declines.
The internet upends this development. Recommendation and consumer feedback are key features in the digital economy. The information gap between sellers and buyers closes mainly because of the possibility of sharing feedback reviews. Empowered by this information, a potential new customer will be better informed about the product he or she is about to buy.
What are the implications for our everyday life?
In the digital age, we have the opportunity to buy products that meet our expectations. But to achieve that, we still have to gather information. However, there is a counter development that comes into play: the ease of buying.
In the digital age, we are constantly seduced to buy something. It’s so easy. Just one click and the deliverer instantly rings the doorbell.
To exploit the full potential of digital shopping, we have to withstand one-click shopping.
This is how I handle it most of the time (sometimes I fail): If I have a strong desire for buying something, first of all, I write that wish into a “wish list”. Then, I push myself to wait at least one day until I allow myself to buy it.
In the meantime, I browse some reviews and trace if I really want that product or service. Sometimes the wish becomes weaker, or I find something else that fits better.
The upshot: Never before have we had better opportunities to buy things we really want and need. The internet improves the quality of the products because the asymmetric information gap closes. But, to benefit from the development, we have to slow down. We have to think and search twice; then, we will likely purchase top of the line.
And if it doesn’t go well anyway, the digital economy provides another way: return shipping.