Information and Transaction

Gresham's Law is an interesting one - that given time, inferior goods will drive high quality goods out of a market.

McMillan uses this law to demonstrate the effects of imperfect information in a market - that is, having either the buyer or seller know more about the good being bought or sold than the other. In the example of Indian milk, buyers that are unable to differentiate between 100% milk and a watered-down 60% milk 40% water mixture end up willing to pay a price that is lower than the cost to produce the best milk, forcing those suppliers out of business. Eventually, only poor-quality milk is being produced, forcing the price even lower.

With perfect information though, this problem is eliminated. Buyers can be sure of what they are purchasing, and sellers can't get away with ripping off customers. Both buyers and honest producers benefit.

So is there perfect information everywhere? Is the market a perfect machine that brings everyone to always get the best quality items at the lowest prices?

Of course, perfect information does not exist everywhere. In reality, if one agent holds more information than the other, they have a distinct advantage in the bargaining process.

Let's look at life insurance as an example - the buyer must talk to an agent about buying insurance. The insurance company, prior to meeting the customer, has no knowledge about this person's health. Thus the buyer has an advantage here, and may be able to get a better deal than if the seller was perfectly informed.

On the other hand, look at used-car salesmen. The buyer knows nothing about the car in question, while the seller has a detailed history. Who wins here? Of course, there are companies and businesses that strive to help the consumer stay informed, but one still can't be certain of the car's history.

So if perfect information is so hard to achieve, can we at least have zero transaction costs?

Not necessarily, though the Internet certainly helps to bring us as close as possible.

McMillan notes that although the Internet allows us to research things and know far more than we would have 20 years ago, transaction costs still exist - whether they are money you have to pay or simply opportunity costs. A concrete example McMillan uses talks of paying $.10 to talk to each merchant. In a more realistic way, that $.10 is time that you could have been doing something else. Transactions cannot take place if the buyers and sellers do not locate one another, and this search does not always come free.