In this chapter, we’ve studied markets in which asymmetric information exists—one party knows more than the other about the goods or services being traded. We saw that asymmetric information can have big impacts on how well markets operate. Under complete information, for example, buyers and sellers in a market engage in mutually beneficial exchanges and partake of the economic surplus created by these exchanges. In the extreme, asymmetric information can cause markets to seize up completely, because buyers and sellers are so afraid of making a decision with a poor economic outcome for them. Such a freeze on market exchanges harms not just the parties with the information disadvantage, but also those with the advantage. This potential for economic harm explains why so many economic institutions have come about to reduce the effects of information asymmetries.

We’ve looked at numerous examples of ways that asymmetric information can show up in markets: adverse selection, moral hazard, and principal–agent problems, and we’ve discussed the steps consumers and firms take to try to reduce their impact. We covered a lot of ground, but it’s important to remember that we really only scratched the surface of this interesting area of economics.

In the next chapter, we study more ways that the well-functioning markets we studied in the earlier parts of this book may fail to deliver outcomes that are socially optimal. Specifically, we investigate the roles of externalities and public goods.