Question

In which of the following situations is an information asymmetry likely to cause problems? \(\left[\mathrm{LO}_{10.1}\right]\) a. Cab drivers know the shortest route to any destination better than their passengers do. b. Managers can't always supervise members of their sales staff, who work on commission. (That is, staff members receive a percentage of the total value of the sales they make.)

Short answer

Both situations show information asymmetry, potentially causing problems.

Step-by-step solution

Understand Information Asymmetry

Information asymmetry occurs when one party in a transaction has more or better information than the other party. This can potentially lead to inefficient outcomes or unfair advantages.

Analyze Situation (a) - Cab Drivers and Passengers

In situation (a), cab drivers knowing the shortest route better than passengers represents a classic case of information asymmetry. Because drivers may use this knowledge to take longer routes without the passengers knowing, passengers are susceptible to overpaying or experiencing longer travel times.

Evaluate Impact of Information Asymmetry in Situation (a)

Due to the information asymmetry, passengers might pay more than necessary if drivers choose to take them on longer routes intentionally. This causes a problem as passengers do not get their money's worth and might lose time.

Analyze Situation (b) - Managers and Sales Staff

In situation (b), the information asymmetry lies in the managers not being able to supervise their sales staff constantly. Sales staff might not work to their full potential or might prioritize higher commission sales, which could be detrimental to overall sales.

Evaluate Impact of Information Asymmetry in Situation (b)

The inability of managers to supervise effectively results in a lack of control, which can lead to problems like reduced productivity or ethical issues if staff acts in self-interest to maximize their commission, potentially harming customer relationships or company reputation.

Key concepts

Transactional Inefficiency

Transactional inefficiency often occurs when one party in a transaction lacks crucial information. This is a direct outcome of information asymmetry. For example, when a buyer attempts to purchase a product or service without knowing all the details, it can lead to an inefficient transaction where the buyer could overpay or receive less value than expected.
In the context of cab drivers and passengers, cab drivers who have more knowledge about optimal routes could potentially take longer, inefficient paths. This results in passengers paying more than necessary.

• Passengers may not have enough information to question the route taken.
• The market fails to achieve an efficient allocation of resources.

This inefficiency is not just about monetary loss, but also about a loss of time and trust.

Managerial Oversight

Managerial oversight is crucial for ensuring that operations are running smoothly within an organization. It involves managers supervising and guiding their staff to align with the organization's goals.
However, information asymmetry can impede effective oversight. For example, sales staff working on commission might not always act in the company's best interest.

• Managers may lack visibility over the daily activities of their team.
• This can lead to unchecked behaviors that might not concur with company policies.

Effective managerial oversight requires reducing information gaps and implementing systems to monitor and improve staff conduct.

Commission-Based Sales

Commission-based sales motivate employees by linking their earnings to the sales they generate. However, this model can create problems if not properly managed.
Without clear guidelines and constant supervision, sales staff might:

• Focus on high-commission products over the actual needs of the customer.
• Overlook customer satisfaction in favor of higher sales figures.
• Pursue unethical sales tactics.

This sales technique, powered by information asymmetry, necessitates a balance between autonomy and accountability to ensure customer satisfaction and brand loyalty.

Cab Driver-Passenger Dynamics

The dynamics between cab drivers and passengers illustrate many practical challenges of information asymmetry. Cab drivers possess advanced knowledge of traffic patterns and routes, while passengers often rely on drivers for safe and efficient travel.
This discrepancy in knowledge can sometimes lead to:

• Cabbies exploiting their superior knowledge for higher fares.
• Passenger frustration due to lack of route transparency.

In such situations, technology such as GPS systems can help level the information field, providing passengers with better insight into the most efficient routes.