Why can asymmetric information between buyers and sellers lead to market failure

Question

Why can asymmetric information between buyers and sellers lead to market failure when a market is otherwise perfectly competitive?

A.

If the buyer and seller have different information about the transaction, the price will not reflect either the average benefit to the buyer or the marginal cost to the seller.

B.

If the market would otherwise be perfectly competitive, then asymmetric information will not result in a market failure because price is equal to marginal cost.

C.

If the buyer and seller have different information about the transaction, the price will not reflect either the marginal benefit to the buyer or the marginal cost to the seller.

D.

If the market would otherwise be perfectly competitive, then asymmetric information will result in a market failure only if the market collapses

Explanation / Answer

C.

If the buyer and seller have different information about the transaction, the price will not reflect either the marginal benefit to the buyer or the marginal cost to the seller.

Asymmetric information leads to adverse selection where Marginal benefit can not be same as marginal cost.

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