Ignorance is Not Blissful
Subject Asymmetric information
Topic Product Markets
Key Words Prices, differential, discounts, special offers, quality, information
News Story

Prices vary between the UK and other countries in Europe. Automobile prices are 21 percent higher in the UK than in Europe, although this is half the differential of a year ago. The price of mobile telephones was formerly much greater but is now similar to Europe. Compared to France, UK consumers still pay more for transport, property, and restaurant meals. However, the French pay more for clothes, household equipment and pharmaceuticals.

Why do consumers put up with the price differentials? In part it is due to the disguising of the true price. Often, there is a bewildering range of prices, discounts and special offers.

The confusion may cause consumers to respond favorably to price cuts, but then they may find that the lower prices are accompanied by reductions in quality. The solution to this particular problem is to publish comparative information, much like consumer watchdog magazines. If consumers know the prices and qualities of the products on the market, they can make more informed decisions. It would also help keep prices low.

(Updated March 1, 2001)

1. The news story indicates that prices differ within Europe, where there are quite short distances between countries. These differentials could be due to imperfect information, we learn.
a) What are the marginal costs of searching for product information, such the price of the product?
b) What are the marginal benefits?
c) Draw a diagram showing information costs and benefits on the vertical axis and the quantity of information on the horizontal axis. Add the curves representing the marginal cost and benefit of information. Mark the quantity of information that results from an optimal search.
d) Explain why prices continue to differ (or quality varies even if the prices are equal) after an optimal search.
e) Why would not consumers want to keep on searching until they had perfect information?
f) Why does this keep prices high?
2. The consumer appears to be at a disadvantage in the news story due to the confusion over prices and quality of products.
a) Do producers and consumers of cars have different amounts of information? Why or why not?
b) When auto producers have more information about quality levels, what tends to happen to the quality of cars? Why?
c) What safeguards could be introduced to minimize the problems of asymmetric information in the selling of new cars? Refer to the article, but also think of other possibilities.
Source Andreas Whittam Smith, "Why do we pay so much for our cars and mobile phones?" The Independent, February 12, 2001.

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