Market Failure: Information Asymmetry

Economic Essay
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Economic Essay
Information asymmetry is a type of market failure encountered in financial markets where one party has more information than the other party in the contract. The two most critical outcomes of information asymmetry relevant to economics are adverse selection and moral hazard. Adverse selection refers to a situation where the party with higher risk opts to hedge the risk, if possible, without incurring proportional costs to the greater threat. On the other hand, moral hazard denotes the second kind of information asymmetry where the actions of one party or the contrary are hidden from the counterparty to the contract (Bergh et al., 2018).
The real-world problem in the working paper, "Do Digital Platforms Reduce Moral Hazard? The Case of Uber And Taxis" by Liu et al. (2018) is the tendency among both taxi and Uber drivers to inflate the meter charge by taking detours on airport routes to make more money. On the other hand, the real-world problem in the working paper "Do Social Connections Reduce Moral Hazard? Evidence from The New York City Taxi Industry" by Jackson & Schneider (2010) is the propensity of lessee-drivers to have worse driving outcomes than owner-drivers as a result of the concealed actions of the former from the latter is incomplete leasing contracts.
The informational symmetry in the working paper by Liu et al. (2018) is that of driver moral hazard. Both taxi drivers and Uber drivers tend to detour on airport routes when they deem that their routing decisions are relatively concealed from the passenger. For instance, taxi drivers are prone to detour on airport routes, particularly those routes used by non-local riders, because they are unlikely to observe the extra distance added by the driver to the fastest route. Non-local riders are more likely than native riders to lack knowledge of local geography or the fastest airport route. Since the taxi pricing formula places a larger weight on distance, the taxi driver earns more for the trip by detouring.
On the other hand, Uber drivers are likely to detour on airport routes with greater surge pricing because the high surge is more than sufficient to offset the possible penalty of detouring. Conversely, the information symmetry in the working paper by Jackson & Schneider (2010) is the tendency among lessee-drivers to have worse driving outcomes than owner-drivers when leasing from members outside their country-of-birth community, owing to the limited ability of the owner to implement social sanctions. Lessee drivers are likely to deter moral hazard when leasing from members of their country-of-birth community due to social sanctions' serious and credible threat.
The moral hazard in the first economic paper is studied using a theoretical framework of driver moral hazard built on previous work by Liu et al. (2017): the authors compared route choices between taxi drivers and Uber drivers by matching trips to ensure they are subject to the same optimal route. Taxi trip records and UberXtrip records for two six-month periods were gathered before granular geographical matching of both taxi and Uber trips was conducted to id...