Gift Cards, Good Cards and Asymmetric Information
Picture this: It is your birthday, and among the countless toys, cards, and other items you’ve received is a veritable mountain of gift cards. While you are glad that people thought of you, you are also a little confused about why so many people gave you gift cards. After all, they are just a less useful version of cash that’s accepted at a small subset of stores and which you either don’t use, don’t spend all of, or use but have to pay the remaining balance of your purchase out of pocket. Yet despite this, gift cards are by far the preferred gift to cash, which has led to tens if not hundreds of millions of dollars being spent on them each year. One explanation of this phenomenon has its roots in the field of asymmetric information, which can also explain key features of car markets, charities, and more.
Asymmetric information is a blanket term in economics for any situation where one side has more relevant information than the other. While philosophers, theologians, and economists have been thinking about this area since at least the first century BCE (Cicero, 2008), widespread and rigorous analysis of asymmetric information only began in the 1970s. But by the time that decade came to a close, three revolutionary papers had been released – “The Market for Lemons” by Akerlof, “Job Market Signaling” by Spence, and “Equilibrium in Competitive Insurance Markets: An Essay on the Economics of Imperfect Information” by Stiglitz – and a new asymmetric information renaissance had begun. While I’ll primarily focus on Akerlof’s work as it is most relevant to this article, I recommend that anyone interested in this field explore all three papers and their implications and have linked each paper at the bottom of this article.
Akerlof’s paper draws its name and inspiration from an industry that has caused many an American stress and annoyance: the market for used cars, where buyers fear buying the titular “lemons”, another name for bad cars (Akerlof, 1970). In this market, used cars lose thousands of dollars in value the moment they leave the lot, regardless of the car’s quality (Akerlof, 1970). According to Akerlof, the reason for this is quite simple – in this market, sellers know whether or not a vehicle is a “lemon” while buyers do not. As a result, buyers can’t offer different prices for good and bad cars and must offer a price between the value of a good car and the value of a bad car. For example, if a good used car is worth 180$ and a bad car is worth 20$, I’ll find myself looking to buy a used car at a price between 20$ and 180$ as I can’t confirm if the car I buy is good or bad. The price offered won’t be equal to the worth of a good used car, resulting in these cars being kept off the market (Akerlof, 1970) and preventing mutually beneficial transactions. And such asymmetries exist in more than just the used car market, with Akerlof himself highlighting their existence in insurance markets (where people have a better knowledge of their health than insurers). Furthermore, Spence highlighted their existence in employment (where employees know more about their capabilities than their employees).
One may assume that in the presence of such asymmetries, markets would fail to operate correctly, necessitating government intervention. However, market participants often find ways to address these problems, allowing them to manage (and sometimes eliminate) asymmetrical information. Their methods for doing so include signaling and screening for relevant information. For example, a car seller could signal the quality of his car by guaranteeing a total refund if the car breaks, while the buyer could require that a mechanic check the car for issues before they purchase it (Akerlof, 1970). There are of course also government solutions to these asymmetries, such as regulating these markets or providing education to consumers and producers on how to obtain missing information.
With the brief introduction of asymmetric information out of the way, I’ll now show how this framework can be applied to various other aspects of our life. To start, I’ll return to gift cards, though I must acknowledge that I’m not even close to the first person to look at gift-giving in this way (Mankiw 2021). When looking through the lens of asymmetric information, one quickly realizes that within relationships, you know how you feel but can only guess how your partner(s) may feel (Mankiw 2021). Gift-giving thus becomes a great way to signal your affection by giving meaningful gifts that show what you know about a partner (Mankiw 2021), like gift cards to stores they love. And a loved one could also use gift-giving to screen your affection by dropping hints about a desired item and seeing if the other listens to them enough to pick it up.
Asymmetric information’s insights also apply to the field of charity, where donors know far less about the credibility of a charity than the charity does. With charity fraud being a significant issue, especially after natural disasters and other mass tragedies, such an asymmetry could threaten charitable donations and much of the civil society that this money supports. Yet once again, signaling and screening help people and groups address the issues as charities can signal their credibility by getting their credibility certified (for a fee, of course), and a potential donor can screen them by looking at their financial statements.
Another field where asymmetric information can be applied is in the current business world, specifically to Enviornmental, Social, and Governance (ESG) Investing. When it comes to ESG, a firm is far more certain of its true feelings about ESG than consumers, which can lead some investors to be skeptical of if a company is truly committed to ESG. By making binding commitments to ESG-related priorities like diversity and inclusion and publicly establishing these commitments, companies can address this asymmetry and signal they are passionate about ESG rather than pretending to value it.
In addition to area-specific applications, asymmetric information can also explain many of the quirks of our modern world. For example, a number of economists have postulated that brand names serve as a signal of the general quality of a good, resolving the asymmetrical information one may encounter in choosing between options (Klein, nd). The reason for this is that a well-maintained brand can be an incredible asset for winning over customers and for expanding into new products, meaning a company has an incentive to preserve its brand reputation by ensuring high quality. Additionally, review aggregators like Yelp exist to let people share reviews of and information about locations, helping prevent informational asymmetry in a number of contexts.
But despite their power, I must acknowledge that methods for dealing with asymmetric information are often limited. Inspectors can be bribed, certifications can be faked, bad brand reputations can cause brands to send bad signals, good reviews can be bought, and so many other signals and screens can be manipulated. Asymmetric information as a whole is also just one of many frameworks for looking at these issues. For example, gift-giving has an incredibly rich symbolic and anthropological history, and branding can also be seen as a way of competing by differentiating products. Yet despite these flaws, asymmetric information remains an incredibly powerful way of considering and explaining different features based on gathering information. So next time you’re wondering why a job requires a certain degree or why employers want certain GPAs, stop to ponder what information this can reveal and how it can resolve key asymmetries.
Works Cited
Akerlof, G. A. (1970). The Market for “Lemons”: Quality Uncertainty and the Market Mechanism. The Quarterly Journal of Economics, 84(3), 488–500. https://doi.org/10.2307/1879431
Cicero, M. T. (2008). On Obligations. Oxford University Press.
Klein, B. (n.d.). Brand Names. Econlib https://www.econlib.org/library/Enc/BrandNames.html
Mankiw, G. N. (2021). Principles of microeconomics (9th ed.). Cengage Learning.
Spence, M. (1973). Job Market Signaling. The Quarterly Journal of Economics, 87(3), 355–374. https://www.jstor.org/stable/1882010
Informational Asymmetry Resources:
The Market for “Lemons”: Quality Uncertainty and the Market Mechanism (https://www.jstor.org/stable/1879431)
Job Market Signaling (https://www.jstor.org/stable/1882010)
Equilibrium in Competitive Insurance Markets: An Essay on the Economics of Imperfect Information (https://www.jstor.org/stable/1885326)
