information asymmetry

Information asymmetry is an imbalance between two negotiating parties in their knowledge of relevant factors and details. Typically, that imbalance means that the side with more information enjoys a competitive advantage over the other party.

Information asymmetry is relevant to most types of negotiations and is particularly significant to game theory, and the related contract theory, which is the study of how two parties come to terms of agreement despite unknown factors and unequal knowledge. In the most common scenario, a seller has more knowledge of the goods or services he offers than the potential buyer. 

George Akerlof introduced the term information asymmetry in his 1970 article, "The Market for 'Lemons': Quality Uncertainty and the Market Mechanism." Akerlof argued that because people buying cars have less complete information about them than car salesmen do, the salesmen are motivated to sell people cars of less-than-average quality. At the same time, because most buyers can’t differentiate good cars from bad cars (lemons), sellers of good cars can’t sell them for what they are worth, comparatively. Akerlof referred to this situation as the “lemon problem.”

To mitigate the risk of getting a bad deal due to information asymmetry – whether buying a car or negotiating a contract – the best practice involves trying to ensure that you know as much as you can and discussing any areas of uncertainty.

See a lecture on asymmetric information and signaling: