Imagine you’re looking through Shein or TikTok shop, and you see a nice phone case that you want to buy. In this situation, the seller of the phone case knows more about the quality of the phone case and you do not. The only information you have is from photos the seller chooses to share, which could be misleading. This means the seller has an advantage over you, creating an imbalance of information. In economic terms, this situation is called asymmetric information.
Asymmetric information is when one party has more information or superior information than the other party in an economic transaction. This gives the more informed party a competitive advantage that they can choose to exploit, in order to gain maximum benefits possible. Asymmetric information leads to moral hazard and adverse selection. In both cases, resources are not being distributed efficiently.
Going back to the phone case scenario, ask yourself “What would I do?” Most people would start looking at the reviews for the product to see if the seller is credible and the product is high-quality. This is called signalling, where the buyer (you) will rely on reviews from other people who already bought the phone case in order to determine if you should buy it. Through this, the buyer is bridging the gap in information and reducing the imbalance. If there are lots of positive reviews, it signals to the buyer that the phone case is high-quality which builds trust and makes the buyer more likely to purchase it.
Through using signalling by checking reviews, the information imbalance is reduced and a few days later you get a new, high quality phone case!