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In microeconomics, a state of perfect information is required for perfect competition. That is, assuming that all agents are rational and have perfect information, they will choose the best products, and the market will reward those who make the best products with higher sales. Perfect information would practically mean that all consumers know all things, about all products, at all times, and therefore always make the best decision regarding purchase. In competitive markets, unlike game-theoretic models, perfect competition does not require that agents have complete knowledge about the actions of others; all relevant information is reflected in prices.
It is law of sociology that perfect information does not exist, and cannot totally exist, due to the presence of deception. For example, a crooked used-car salesman could sell a consumer a car that he knew was only going to last another 1000 miles, as a car that will last much longer. He as the seller has an advantage against the consumer. This knowledge of asymmetric information, as the consumer does not have as good information about the cars as the seller does, can also lead the consumer to assume that the cars are in general of poor quality. This will again give the seller an incentive not to sell high quality cars as the consumer will have no way of knowing that the car is of higher quality, and thus not be willing to pay a higher price for the car. Sellers can attempt to differentiate themselves from other providers by various guarantees, offers and independent assessments.
Advertising serves two roles. Firstly, it allows producers to increase the amount of available information by providing consumers with more information about their products. Furthermore, it allows producers to use a lack of perfect information to counter product deficiencies by way of advertisement. In theory, the more information that exists about products, the more "free" a market is. In practice, it is also the quality of the information that counts.
- Complete information
- Extensive form game
- The Economics of Groundhog Day by economist D.W. MacKenzie, using the 1993 film Groundhog Day to argue that perfect information, and therefore perfect competition, is impossible.
- Fudenberg, D. and Tirole, J. (1993) Game Theory, MIT Press. (see Chapter 3, sect 2.2)
- Gibbons, R. (1992) A primer in game theory, Harvester-Wheatsheaf. (see Chapter 2)
- Luce, R.D. and Raiffa, H. (1957) Games and Decisions: Introduction and Critical Survey, Wiley & Sons (see Chapter 3, section 2)
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