Economics
Market Failure: Asymmetrical Information
Economics teaches that when certain conditions are met, markets allocate goods and services efficiently. But when those necessary conditions are not present, the result is often what economists call a market failure—a failure of the market to produce efficient results.

For example, for markets to work well, buyers and sellers must have access to the same information about the goods being sold. Suppose you need to buy a used car but you lack the ability to distinguish between dependable used cars and "lemons" (i.e., cars prone to breaking down). Your local used-car dealer, however, knows exactly what is wrong with each car on his lot. Of course, he is probably not going to tell you the problems with the car you are thinking about buying; if he did, you might not buy it. So he tells you how great the car is, and you buy it. A week later, the car breaks down—you bought a lemon.

Economists call this problem asymmetrical information. It leads to a market failure because it results in inefficient transactions that would not have taken place if both the buyer and the seller had access to the same information. You wouldn't have bought the car if you had known it was a lemon.

The asymmetrical information problem occurs in unregulated securities markets. When investors purchase corporate securities, they lack knowledge about the securities' risks and potential rewards. But the companies issuing the securities know very well the risks and rewards the securities offer. In this situation, investors are unable to make efficient decisions about which securities to purchase, resulting in a market failure.

The Securities Act of 1933 attempts to remedy the asymmetrical information problem in the securities market. The act requires that all securities issuers disclose certain information to investors in the form of a prospectus. As a result, investors can appraise the value of the securities for themselves and make better investment choices.

Source: George A. Akerlof, "The Market for 'Lemons': Quality Uncertainty and the Market Mechanism," Quarterly Journal of Economics. 84 (1970), p. 488.