Information failure lead to situations where

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information failure lead to situations where consumers either overconsume or underconsume a particular good or service. This leads to allocative inefficiency and thus market failure.
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(a) Explain how information failure could lead to market failure. [10] Suggested Body 1: Imperfect Info Example: Sugary drinks MPB: enjoyment of the taste and burst of energy when consuming the sugary drinks MPCperceived: price when purchasing the sugary drink MPCactual: possible long-term damage on consumer’s health e.g. obesity and diabetes As such, MPCperceived < MPCactual leading to over- consumption (diagram to show) over-allocation of resources market failure deadweight loss of area ABE1.
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(a) Explain how information failure could lead to market failure. [10] Suggested Body 1: Imperfect Info Example: Sugary drinks Consumers make decisions at MPB = MPCperceived Qm to maximise their welfare/satisfaction. But, if he took into account actual cost, he should have made the decision at MPB = MPCactual Qs Qm > Qs over-consumption Deadweight loss of area ABE1 market failure *Note: Students are free to use any other examples to illustrate the concept of imperfect info using the framework. Other examples could include consumption of cigarettes, education or medical services. Students are then to explain the MPB, MPCperceived and actual according to the examples they have chosen.
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(a) Explain how information failure could lead to market failure. [10] Suggested Body 2: Asymmetric info (adverse selection) Example: Second-hand cars Sellers of second-hand cars will have more knowledge of their cars than buyers. These knowledge include engine faults, aircon compressor conditions, etc. They are likely to withhold this information from buyers in order to sell their cars at a higher price. Buyers are aware of this and thus offer a lower price for second hand cars. However, sellers of good quality second hand cars will not want to sell their cars at such a low price. This eventually results in sellers of high quality second hand cars leaving the market, resulting in only low quality second hand cars being available for sale, ultimately causing market failure. *Note: Students are free to use any other examples to explain the concept of asymmetric information. Other examples could include health insurance market, or supplier-induced demand for medical services where doctors have more knowledge than patients on different levels of medical care.
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(a) Explain how information failure could lead to market failure. [10] Suggested Body 3: Asymmetric info (moral hazard) Example: Home (fire) insurance Moral hazard occurs when one party has unequal information about the behaviour of the other party after the transaction has taken place.
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