Module – 3
Economics of Uncertainty
I. Information
The traditional consumer behaviour theories and classical market models assumed that
consumers and producers have complete information about economic variables that are
relevant for the choice they face. However, this is not true. The consumers and producers are
not perfectly informed about all economic variables which are relevant in consumer’s choice.
Thus information about the economic variables which are relevant in consumer’s choice is
very important. In economic perspective, information refer the knowledge obtained by the
consumer related to the import economic variables such as price; utility, quality of product
etc. through investigation and search. Thus one of the most important cost of purchasing a
product is the time and money spend by the consumer to seek information about the product
that is what are the properties of the product, what are the alternatives, how good is the
product, how safe it is etc. The time and money spent by an individual to seek information
about a product is called search cost.
II. Properties of information
All good information has the following characteristics.
a) Subjectivity
The value and usefulness of information are highly subjective, because what is information
for one person may not be for another.
b) Relevance
Information is good only if it is relevant. That is the information is pertinent and meaningful
to the individuals to take decision related to his choice.
c) Timeliness
Information must be delivered at the right time and right place to the right person. Otherwise
it has no usage.
d) Accuracy
Information must be free of errors, because faulty information can result poor decisions and
reduce the confidence of users.
e) Correct information format
Information must be in the right format to be useful to the decision maker.
Dr Ratheesh C, Dept.of Economics, FMNC, Kollam Page 1
, f) Completeness
Information is said to be complete if the decision maker can satisfactorily solve the problem
by use the information.
g) Accessibility
Information is useless if it is not readily accessible to decision makers, in the desired format,
when it is needed.
III. Asymmetric Information
In transaction of goods and services often one party, i.e., seller or buyer has more
information regarding the quality of the product or services than the other party. This is called
asymmetric information. The problem of asymmetric information exist both in labour market
and product markets. For example, in labour market the workers usually know their own
skills and abilities better than employers. Similarly in second hand used car market, the
owners of used car knows more about the quality of used cars as compared to the perspective
buyers. Moreover, the managers know more about their firms’ costs, competitive positions,
and investment opportunities than do the firm’s owners.
One of the important economic problems related to asymmetric information is adverse
selection. Adverse selection arises when products of different qualities are sold at a single
price due to buyers or sellers are not sufficiently informed to determine the true quality at the
time of purchase. As a result, too much of the low-quality product and too little of the high-
quality product are sold in the marketplace. Or the low quality products are completely driven
out the high quality products from the markets. This is called the problem of adverse
selection.
However, in real world, the functioning of numerous institutions reduces the problem of
asymmetric information. The problem of adverse selection can reduce by acquisition of more
information by the party lacking it. In market, the sellers of high quality goods and services
convince consumers that their product quality is through reputation and standardisation.
Moreover, the warranty and guaranty provided by the sellers to the product is also give
market signals about the quality of the products offered by them.
IV. Choice under Uncertainty
In traditional theories consumer’s choice is analysed under the assumption of certainty.
However, in the real world producers and consumers choice are associated with uncertainty.
The demand and supply of inputs as well as output fluctuate overtime. This raises the
Dr Ratheesh C, Dept.of Economics, FMNC, Kollam Page 2
Economics of Uncertainty
I. Information
The traditional consumer behaviour theories and classical market models assumed that
consumers and producers have complete information about economic variables that are
relevant for the choice they face. However, this is not true. The consumers and producers are
not perfectly informed about all economic variables which are relevant in consumer’s choice.
Thus information about the economic variables which are relevant in consumer’s choice is
very important. In economic perspective, information refer the knowledge obtained by the
consumer related to the import economic variables such as price; utility, quality of product
etc. through investigation and search. Thus one of the most important cost of purchasing a
product is the time and money spend by the consumer to seek information about the product
that is what are the properties of the product, what are the alternatives, how good is the
product, how safe it is etc. The time and money spent by an individual to seek information
about a product is called search cost.
II. Properties of information
All good information has the following characteristics.
a) Subjectivity
The value and usefulness of information are highly subjective, because what is information
for one person may not be for another.
b) Relevance
Information is good only if it is relevant. That is the information is pertinent and meaningful
to the individuals to take decision related to his choice.
c) Timeliness
Information must be delivered at the right time and right place to the right person. Otherwise
it has no usage.
d) Accuracy
Information must be free of errors, because faulty information can result poor decisions and
reduce the confidence of users.
e) Correct information format
Information must be in the right format to be useful to the decision maker.
Dr Ratheesh C, Dept.of Economics, FMNC, Kollam Page 1
, f) Completeness
Information is said to be complete if the decision maker can satisfactorily solve the problem
by use the information.
g) Accessibility
Information is useless if it is not readily accessible to decision makers, in the desired format,
when it is needed.
III. Asymmetric Information
In transaction of goods and services often one party, i.e., seller or buyer has more
information regarding the quality of the product or services than the other party. This is called
asymmetric information. The problem of asymmetric information exist both in labour market
and product markets. For example, in labour market the workers usually know their own
skills and abilities better than employers. Similarly in second hand used car market, the
owners of used car knows more about the quality of used cars as compared to the perspective
buyers. Moreover, the managers know more about their firms’ costs, competitive positions,
and investment opportunities than do the firm’s owners.
One of the important economic problems related to asymmetric information is adverse
selection. Adverse selection arises when products of different qualities are sold at a single
price due to buyers or sellers are not sufficiently informed to determine the true quality at the
time of purchase. As a result, too much of the low-quality product and too little of the high-
quality product are sold in the marketplace. Or the low quality products are completely driven
out the high quality products from the markets. This is called the problem of adverse
selection.
However, in real world, the functioning of numerous institutions reduces the problem of
asymmetric information. The problem of adverse selection can reduce by acquisition of more
information by the party lacking it. In market, the sellers of high quality goods and services
convince consumers that their product quality is through reputation and standardisation.
Moreover, the warranty and guaranty provided by the sellers to the product is also give
market signals about the quality of the products offered by them.
IV. Choice under Uncertainty
In traditional theories consumer’s choice is analysed under the assumption of certainty.
However, in the real world producers and consumers choice are associated with uncertainty.
The demand and supply of inputs as well as output fluctuate overtime. This raises the
Dr Ratheesh C, Dept.of Economics, FMNC, Kollam Page 2
