in Mental Models

Mental Model: Information Asymmetry

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The concept of information asymmetry seems fairly obvious from its name. However, as a mental model, it deserves deeper study to fully understand all of its nuances.

At its most basic, information asymmetry describes a situation where two parties have different quantities or qualities of information. When one person has either more or better information than another, they have a massive advantage.

This mental model shows up a lot in investing, but can be applied in many areas of life.

For example, I remember being intuitively aware of information asymmetry during my poker days, despite not knowing the concept by name.

Information Asymmetry in Poker and Other Games of Strategy

In Poker

By design, poker is a game of incomplete and asymmetric information. The information is incomplete because you don’t know your opponent’s hand. It’s asymmetric because you either act before or after your opponent based on your position.

This is what makes “having position” (acting after another opponent) so powerful. By definition, you have more information than they do when making a decision and should be able to take advantage of that fact.

Any poker player worth his salt will make more money per hand while “in position” than while “out of position.”

In Competitive Video Games

In many competitive video games, “game knowledge” is exceptionally underrated. Most games have a technical skill component (physically being able to execute), and a meta-knowledge component (knowing how the game works on a deep level).

While technical skill is important, most players who rise through the ranks do so on the back of their game knowledge, along with their ability to control their emotions. Those that have high levels of game knowledge have a massive informational advantage over other players, even if both players have the same level of technical skill.

Another Flavor of Information Asymmetry

As the poker industry grew, some poker players started businesses coaching and training other players. As more people got into online poker for its lucrative money-making opportunities, the demand for high-quality training increased. However, there weren’t many places to go to get this information.

I remember having to scour forums and chat rooms to get in touch with skilled poker players just to pick their brain about strategy, which was quite inefficient. It wasn’t until the advent of poker training sites that high-quality poker knowledge was more accessible to the masses, which was fantastic…unless you were already a highly-skilled player.

These training sides began to erode the informational advantage that highly-skilled players had over the competition. Players who were once dominant at their level started to win less from mediocre players or break even with players slightly worse than them.

Of course, these skilled players also had the opportunity to improve their play, but the simple fact is that the poker training and coaching markets made the games harder because high-quality information was easier to attain.

The lesson here is clear: eroding information asymmetry in a market is a great way to create a successful business. 

Examples of Information Asymmetry in Common Industries

  1. Landlords: Know more about their properties than tenants
  2. Mortgages: Borrowers know more about their ability to repay a loan than a lender, lender may not do enough due diligence
  3. Car Insurance: Companies cannot pinpoint individual’s risk accurately so they must pool people
  4. Students: Some are more aware than others of what they must do to get into a prestigious school, despite equal
  5. Doctors: More aware than patients of drugs and appropriate treatments
  6. Used Car Salesmen: Knows more about quality of car they are selling than a buyer
  7. Insider Trading: Closer someone is to a company’s operation, more information they have to trade on relative to others

Other situations:

  1. Vintage clothing experts can go into a thrift store and pick out items that are worth far more than they’re being sold for to resell them.
  2. People running estate sales, garage sales, or storage sales usually know far less about what’s being sold than the people rummaging through, leading to incredible deals.

Using Information Asymmetry In Your Life

There are an unlimited number of ways to apply this concept in your life. One way is to realize when you have an advantage in either the amount or quality (or both) of information and use that to your benefit:

  • You’re selling an item and you know more about its quality and condition than a buyer
  • You know more about the fundamentals of a game than another player and can exploit that advantage
  • You’re hiring at your company and know what you pay other employees for the same role, but the potential hire does not

Another way to use this concept is to seek out market where there information asymmetry is rampant and seek to equalize it:

  • Glassdoor arms job-seekers with information about company culture, salaries, and quality of life.
  • The Wirecutter arms consumers with in-depth information about consumer products.

Originally published on Kevin’s personal blog.


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