ChainWhat it assumes · how to break it
Start
Sellers of financial products, such as pensions and loans, know far more about the charges and risks than many of the customers who buy them.
1
As a result, buyers cannot judge the true cost or quality of the product before they buy it.
asymmetric information
asymmetric information
Assumes: The product is complex and hard to compare.
But: Comparison websites and required disclosure of charges make it easier for buyers to compare products.
2
This means sellers can charge higher prices or sell unsuitable products to the least informed buyers.
asymmetric information · exploitation
asymmetric information · exploitation
Best link to attack
Assumes: Sellers can exploit the gap without penalty.
Assumes: Sellers can exploit the gap without penalty.
But: The Financial Conduct Authority can require firms to treat customers fairly and can order compensation, as it did after the mis-selling of payment protection insurance.
3
Consequently, buyers with less financial knowledge pay more for the same product or end up with products that do not suit them.
inequity · consumer detriment
inequity · consumer detriment
Assumes: Less informed buyers cannot get advice.
But: Independent financial advice is available, though it is costly, so it is used more by higher-income households.
4
Therefore, the outcome is unfair: better-informed sellers gain at the expense of the least informed buyers, who are often among the most vulnerable.
equity · distribution of welfare
equity · distribution of welfare
Assumes: The least informed buyers are also the most vulnerable.
But: Wealthy buyers of complex investments can also be misled, so losses are not confined to vulnerable households.
End
The outcome is inequitable: the least informed and most vulnerable buyers pay more or get worse products, while sellers gain.
Evaluation chain
- E1However, the unfair outcome depends on sellers being able to exploit the information gap without penalty.
- E2If regulators require clear disclosure and punish mis-selling, exploiting buyers becomes costly for firms.
- E3As a result, fewer buyers are misled and those who were may be compensated, as after the payment protection insurance scandal.
- E4So the unfair outcome is reduced by regulation, though compensation comes only after the harm and not every buyer claims it.
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Questions this answers
- Explain how asymmetric information can lead to an unfair outcome.
- Analyse why consumers of financial products may be disadvantaged by an information gap.
- Discuss whether regulation is the best way to protect consumers from asymmetric information.
Diagram
No standard diagram. Use the mis-selling of payment protection insurance as evidence of buyers being exploited through asymmetric information.
Reverse and related
Buyers know more than sellers, e.g. people buying health insurance knowing their own risk → adverse selection, so prices rise for everyone.