Definition
Information asymmetry occurs when the two sides of a transaction do not have equal access to relevant facts. One party — often the seller, the borrower, or the insured — knows something material that the other party cannot easily observe.
This imbalance is a recognized source of market failure. When buyers cannot tell good products from bad, or lenders cannot tell safe borrowers from risky ones, markets can price poorly, shrink, or break down entirely.
Why it matters
How it works
Information asymmetry produces two distinct problems. Adverse selection happens before a deal: when quality is hidden, buyers offer only an average price, the best sellers withdraw, average quality falls, and the market unravels. Moral hazard happens after a deal: once insured or funded, a party may take more risk because it no longer bears the full cost. Markets respond with mechanisms that close the gap — signaling (credentials, warranties, brands), screening (credit checks, deductibles), reputation systems, and disclosure regulation. The persistence of these institutions shows how central information problems are to real-world economics.