Imagine a marketplace where people are selling cats in bags. One seller has a beautiful, colorful bag with the label “elite Persian cat,” another has a simple canvas bag labeled “mouse-catching cat,” a third one says “ordinary cat, inexpensive,” and the fourth has a photo of a fluffy cutie stuck on the bag, and so on. It’s impossible to check the contents of the bags. Each bag has a different price. Which one should you choose? This is exactly the situation consumers find themselves in when buying something from various sellers. Of course, consumers will think they are reasoning logically when making their choice:
- Some might think that a pricey silk bag with a staggering price tag must contain a worthy cat. But if there are bricks inside, then it means that prestigious cats now look like that.
- Someone will choose a bag with a handle: since they don’t know what the cat is like anyway, at least they’ll make it more convenient for themselves to carry the bag.
- Someone might choose a sturdier bag, thinking that the cat inside won’t be able to scratch its owner.
- Someone went to the market with a specific goal and will buy a bag labeled “cat-mouse catcher,” believing that the bag most likely contains a cat that can catch mice.
- Someone will ask all the sellers to weigh the bags and will choose the heaviest one. Or maybe the lightest, who knows?
But most people will act, as they believe, quite pragmatically. They will choose the cheapest bag with a cat, since it’s still unknown whether there’s actually an animal inside.
The other sellers, seeing how quickly the cheap cats in bags are selling, will start lowering the prices of their offerings. In this situation, the highest profit and, consequently, the best deals and the highest sales volumes will be secured by those who don’t even have a cat in a bag. Such a seller can lower the price to the limit, pushing all the others out of the market, as it simply won’t be profitable for them to sell their cats under those conditions. Those who remain in the market will also be selling bricks, but not cats. Meanwhile, the most cunning will promote ideas that expand the definition of a cat to include a “ceramic parallelepiped with holes.” You might say that this is impossible? Then take a look at the games with “megabytes”/millions of bytes among hard drive sellers, or read about the contents of products that are still labeled, according to their packaging, as “cheese,” “sour cream,” “butter,” or “nut-chocolate spread,” which is made up of 75% palm oil.
Such markets are referred to as “markets with asymmetric information”: the seller knows more about what is in the bag than the buyer. It has been proven that in the absence of some market regulator, such markets quickly collapse. Real cat sellers have no place there—they incur losses, and consumers begin to refuse bricks and become distrustful even of bags with real cats.