Imperfect information
Ostrom’s institutional analysis of common pool resources identified the process of acquiring information for both initial system setup and monitoring as a significant cost that in some cases could be too high for there to be any free net economic rent available to appropriate to the users (Ostrom, 1990). Market are systems of coordinating information using the pricing mechanism. Equitable transmission and distribution of information to participants is one of the conditions for an efficient market. Real markets however are not perfect and there are many forms of information asymmetry, where one or a group of participants has an advantage of information access to other participants. Some forms of information asymmetry may be unavoidable as an intentional design feature to reward the effort of “discovery” of new information. Any form of asymmetry could enable the one holding the information with more advantage than they would have if everyone had the same information. Such a situation is known as an “arbitrage” whereby someone can make a risk-free profit through the use of information that has not been factored into the price (Easley, 2010). Imperfections in transmission of information occur both at the source through asymmetry by withholding and the destination due to inattention.
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Asymmetry and the market for lemons
Proprietary, private information can be a strategic tactic used by firms to withhold information through trade secrets, confidentiality, non-disclosure agreements to safeguard their market advantage. If the asymmetry between two groups in a market becomes too widespread markets can fail through a process described by Economist George Akerlof as the “market for lemons” (Akerlof, 1970). In such scenarios, one group - the “lemons” hold an asymmetric advantage of information that enables them to either sell or buy for an excess rent above the true value. Since everyone participating in the market is aware that such groups exist, but they do not know who, they pass this premium on as a cost to everyone else participating. Those who do not have this advantage are priced out and eventually the only participants left in the market are the lemons along with those too careless or uninformed to avoid them. Examples of such markets range from used cars to employment and can occur in any circumstance where one group has a persistent asymmetry information advantage over another group (Akerlof, 1970).
Inattention
The other side of information asymmetry are those who do not absorb the information into their decision making process either consciously or unconsciously. Just as the physical constraints of neural capacity sets limits on how many relationships one can keep tabs on in one’s social circles, they also set limits on attention. “behavioral inattention” (Gabaix, 2017) constraints can be substantial and widespread and influence market pricing dynamics. Researchers have attempted to quantify how different degrees of attention to different types of information affect elasticity to prices. In particular, sales taxes can attribute a significant level of their in-elasticity to inattention compared to the uninformative final round-off digits of an odometer which receive an ostensibly inappropriate sensitivity to car prices at auctions (Gabaix, 2017).
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