Signalling and Screening
A solution to asymmetric information is signalling. Individuals and firms use
signalling to reveal information to an uninformed party. There are two main examples
of signalling in the economy : advertising and education.
Firms use advertisements to provide information about their product or service to the
public (e.g.) a new hair product or a new and improved android mobile phone. For a
firm to provide an effective signal that works, it will have to cost. Advertisements in a
magazine or on TV are an effective way of promoting a product or service as
customers will see the product, try it, and if they like it, they may then soon become a
regular customer. Sometimes in magazine advertisements, the advertisement itself
will include ‘as seen on TV’ written on it which makes the product seem as if it’s of a
higher quality as the customer can see that the firm are willing to pay for the cost of
advertising their product on television.
In education, a graduate will include the university in which they got their degree on
their curriculum vitae in order to provide the employer with information about how
capable their skills are. The cost of the signal in an educational aspect is the cost of
the education itself. The graduate will have paid for the education in the university in
order to use it on their curriculum vitae as a signal to the employer.
Screening is when an uninformed party takes actions in order to reveal hidden
information from an informed party. For example, a person buying a horse may not
know if the horse has an underlying problem or dormant injury and would therefore
request that the horse be checked over by a vet. If the owner of the horse refuses this
request, this would raise suspicions to the buyer that the horse has an underlying
medical condition.
A more subtle example of screening would be when a firm selling car insurance
offers two different kinds of policies; one offering a high premium and covering the
full cost of any accidents, the second offering a low premium but having a €1500
excess. This means the driver would have to cover the cost of the first €1500 of the
damage and the insurance company would cover the rest. This would then reveal the
more reckless drivers from the safer drivers as the reckless drivers would not like the
thought of paying €1500 every time they have an accident on the roads, so they
would then choose the high premium policy.