Asymmetric Information and Market Prices

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INFORMATION AND ECONOMIC THEORY

A key strategy for corporate growth and development is innovation.  Innovation generates proprietary information, company-specific knowledge, and new technology.  A company’s products and services embody past innovation and the sum of proprietary information.  

One of the assumptions of the perfect competition model is complete information.  All participants in a market know all relevant information.  As discussed in an earlier tutorial, Introduction to Information and Economic Structure, this assumption is unrealistic in an imperfectly competitive economy dominated by large corporations.

Proprietary information that cannot be duplicated by other companies allows a company to differentiate its products and services from those of other companies.
Differentiated products and services reduce competition from other companies and limit the ability of a supplier or customer to play off one company against another.

When companies negotiate market transactions including price, proprietary information becomes asymmetric information.  Asymmetric information is what one party to a market negotiation knows that the other party does not know.  

Proprietary information becomes asymmetric information when corporations compete and negotiate.  Asymmetric information influences the relative market power and bargaining power of the two companies and the determination of market prices. This is separate from the transaction cost explanations of how markets function.    

Asymmetric information is a source of sales growth and economic profit (profit above the opportunity cost of capital).  It explains one link between innovation and economic profit.

ASYMMETRIC INFORMATION, LARGE COMPANIES AND PRICE

In the real world of modern economies dominated by large corporations, prices are not set by industry supply and demand. Prices are negotiated by companies along the supply chain.

Price negotiation is an explicit means of setting prices. The negotiated price will be a function of asymmetric information and other factors, such as relative bargaining skill.

In a world of large corporations with market power, differentiated products and services, and asymmetric information, price is indeterminate. Price negotiations take place in two stages.  In a bilateral oligopoly, corporations cooperate to generate a positive-sum game and then negotiate price within a range of possible prices, a competitive zero-sum game.

Companies begin discussions (cooperate) to see if there is a positive sum game, that is, a market transaction that benefits both companies. A positive sum may exist over a range of prices. The companies then begin to negotiate price and sales terms.  This is a zero-sum game that determines the distribution of profit. 

Professor Hayek emphasized that prices are information signals.  A change in relative prices changes the behavior of market participants. But in a world of bilateral negotiations between large companies, prices are set through negotiation. 
If prices are negotiated over some indeterminate range, changes in prices are more likely an indication of changes in relative market and bargaining power.
Relative bargaining power, in turn, is partly a function of innovation and asymmetric information.

Even when products have public list prices, the final net price is negotiated.  Sales reps and purchasing agents often have detailed and continuous negotiations over such variables as advertising and marketing allowances, volume and special discounts, returns policy, credit terms, shipping costs, and other factors that determine net price.

Gathering information about negotiating partners reducing asymmetric information.
It is a part of market transaction cost. But this strategy is never totally successful as companies can protect much of its internal information, knowledge and technology.

When a company’s proprietary information, knowledge and technology diffuses throughout the economy over time, becomes general information, a company should continue to innovate and generate new proprietary information, firm-specific knowledge and new technology, creating new sources of asymmetric information that can be used in future price negotiations.

Corporations will have proprietary knowledge before the negotiations begin. 
Companies will spend time and money to obtain information about customers and companies across from them in their two markets (input and output).  But they cannot have complete information because other companies possess proprietary information.  An alternative is to invest in gathering more information, turning information into knowledge or develop new or improved technologies.

Learning more about a corporate customer or supplier over time may create another form of asymmetric information and a market imperfection.  A current supplier may know more about its corporate buyer than any potential competitive suppliers; the gap may widen over time. This decreases the chance that a potential supplier can compete with a current supplier. 

This view of market transactions is more like a game of poker than an economic market transaction.  Knowledge is also a basis for credible threats and bluffing. 
Many successful entrepreneurs and financial company founders were poker players, including Bill Gates. Bill Gates bluffed IBM into giving up all rights to the software that became the basis for Microsoft.  (Paul Carroll, Big Blue:  The Unmaking of IBM)

Gathering information and negotiating prices and contracts are part of transaction costs. But they have little to do with the decision to produce internally vs. buy from other companies.

Information technology, as a subset of technology, is generated internally in the economic system, mostly in corporations.  Companies compete partly on the basis of internally created proprietary information that is used in market transactions. 
This view transcends the usual dichotomy between vertical integration (internal production) vs. market transaction.


TURNING PROPRIETARY INFORMATION INTO PROFITS

 

During the Gulf War, profits of some European oil companies may be increased by 15-20% from trading oil – buying oil from other companies and selling it to buyers who are having trouble getting oil. Added to profits from long-standing trading in volatility and spreads. Arbitrage over time or from different sources or between different regions.

 

Trading based on their companies “unmatched intelligence on supply, demand and the direction of price thanks to the vast operations … oil and gas fields refineries, terminals, storage facilities and more.” Expanded trading into LNG. Global contacts with customers.

 

BP, Shell and Total may make $15-$20 billion in pre-tax profit from trading in 2026. Higher for return on capital since little capital used for trading.

 

In a good year, a trader might make more than the salary of the company’s CEO.

 

The Economist, “Liquid gold:  Big oil’s secretive trading arms are having an extraordinary year,” July 4, 2026.

 


SUMMARY AND COMMENTS

Investment in information, knowledge and technology creates asymmetric information between two companies. Asymmetric information helps to determine the outcome of price negotiations through its influence on bargaining positions. The negotiated price determines how profit is divided up. 

There is a price range before negotiations begin; actual market price is determined by negotiation.

Corporations spend resources to gather information about other companies but there cannot be complete information in a market because of proprietary information. The benefit may be more market power and a better negotiating position but it could also be an “arms race” with no change in the relative bargaining positions of two companies.  Combined with the indeterminate price range, there is no reason to believe that the negotiated price is an “efficient” outcome.






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