World Bank Document

Reduction of imperfect information

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Reduction of imperfect information
Problems arise when consumers, producers, or governments do not have 
all the information they need to make sound purchasing, investment, 
or policy decisions. Certain standards draw their utility from conveying 
information that corrects for problems of imperfect information.
Minimum safety standards are the most straightforward example of 
standards used to solve imperfect information problems. By conveying 
information about the harmful effects of products, they allow custom-
ers to avoid products that might negatively affect them, the public, or 
the environment, and they allow regulators to exclude unsafe products 
from the market. These standards thus reduce the societal costs of deal-
ing with potentially harmful effects of certain products. These savings in 
turn allow a more effi cient allocation of resources and can contribute to 
economic growth.
Standards can also reduce the transaction and search costs that are 
caused by imperfect information. This is another role of minimum safety 
standards, but it can also be accomplished by quality standards and prod-
uct description standards. These standards allow buyers to confi rm that 
products and processes have the characteristics they want without the 
additional transaction costs of independent testing. By codifying market 
preferences, standards also save sellers the additional costs of defi ning 
consumer preferences.
By reducing information asymmetries, standards can help mitigate 
adverse selection problems. In many situations of imperfect information, 
the seller has better information than the buyer. Sellers cannot charge a 
price premium for high-quality products if buyers are unable to distin-
guish them from low-quality products. If the costs of high-quality pro-
ducers are greater than the costs of low-quality producers, high-quality 
producers will undersupply or could even be driven out of the market. 
Minimum quality or safety standards help consumers confi dently dif-
ferentiate product quality and safety, and hence help mitigate adverse 
selection problems (box 2.1).

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