Knowledge is power! Information influences how well markets work

Knowing more about the economy and politics is an advantage not only for individuals but also for society as a whole. If we have better knowledge and more information, we are able to make better decisions, which benefits everyone in the end. Professor Christoph Weiss from WU’s Department of Economics has investigated how more information makes markets work better.

We’ve all been there: You’re a tourist on vacation in a foreign country. You’re unfamiliar with the pricing policies of the restaurants and bars at your destination, so you’ll likely end up paying way too much for your pizza. The well-informed locals, in contrast, choose restaurants where they know they’ll get better value for their money. Having more information is clearly an advantage for the local population in this scenario.

This example also illustrates why the same products are sold at different price points in a market. We call this phenomenon price dispersion. Some of the restaurants charge lower prices to attract the more well-informed customers, while other charge high prices and hope they will be chanced upon by uninformed tourists who just don’t know any better.

More information can lead to lower prices

In competitive markets, the way price levels are set is sometimes very similar to the mechanism in our example about overly expensive restaurants in foreign cities: If there is a lack of information or transparency in the markets, companies can get away with charging higher prices. If consumers have better information and the number of well-informed customers increases, however, there will be fewer restaurants that offer poor value for money. This means that average market prices will go down. In the end, this is also beneficial for uninformed tourists. If there are more good-value restaurants around, tourists are more likely to choose one of these inexpensive place to eat. This positive effect, where uninformed customers benefit from how well-informed customers influence the market, is called a “positive information externality.” In the scenario we discussed above, the markets don’t work particularly well. Government interventions aiming to provide better information or increase transparency – for example in the form of consumer, competition, and regulation policies – can help to improve the situation.

These points also apply in a broader context: The better informed we are, the better the decisions we make. And better decisions are an advantage for society as a whole.