Asymmetric Information in Tourism

Asymmetric Information (AI) is when one party to the trade has more information that the other party to the trade.

Consider a situation where there are low and high quality goods. The seller knows whether the good is low or high quality, but the buyer does not. Furthermore, suppose a high quality good is worth 100 and a low quality good is worth only 50. In that case a buyer, not knowing whether a good is high or low quality, would offer something less than 100, but more than 50; perhaps 75. But if the price is 75 the sellers of high quality goods will not want to sell. So only the low quality goods are left.

Solutions to the AI Problem

  1. If the seller issues a warranty, then the buyer will pay the high quality price knowing that the seller is obligated to bear the expense of replacing the low quality good. However for a warranty to work it must be the case that the buyer can prove the good is low quality, and it must be the case that the warranty can be enforced at low cost.
  2. If the seller will gain a bad reputation as a seller of low quality goods, then this may be sufficient to ensure goods are of high quality. For instance, suppose a seller of used cars has a reputation of selling high quality cars. If the seller then sells a person a low quality car, and therefore gains a bad reputation, he will lose the business of those that want high quality cars. So to preserve a good reputation he will sell high quality cars. For this to work, however, it must be the case that buyers can transmit information to each other at a low enough cost for the seller to have a reputation.
  3. If a firm can produce and sell information on the quality of goods, then this can solve the AI problem. For instance, a firm might test new cars and provide information on the quality of new cars in a book. Someone can then buy the book to get accurate information before buying a car. The condition for this to work is that somehow the firm must be able to prevent those that buy the book from giving the information to others for free. That is, it must stop free-riders. If it cannot stop free-riding, then the firm cannot profitably exist. Theoretically, one book could be purchased, and all people that value the information could share the one book. The firm could not make a profit, and thus the information is not produced. All information has a free-rider problem, the question is to what extent does this exist. If the problem is not too severe, then private firms may produce information.

Application to Tourism

Tourism is subject to asymmetric information problems. When a tourist books a holiday, it is purchased without ever inspecting the quality of the accommodation, transportation, food, tourist sites, etc. Hence the buyer (the tourist) has less information that the sellers (hotels, airlines, etc.). Given this, the problems of AI can arise. Which, if any, of the above solutions can solve these problems?

  1. Warranties? The fact that one must be able to prove a good is low quality makes the use of warranties in tourism unlikely. The quality of tourism services is very subjective, depending on people’s preferences. Moreover, it may be costly to enforce a warranty over international borders.
  2. Reputation? The question is whether reliable information can be transmitted at low cost. Certainly the internet has reduced the cost of sharing information on the quality of a hotel, etc. However, there is still probably far from complete information. This reputation effects can only partially solve the problem.
  3. Private Information? Are there private firms that produce information? Yes. First, travel guide books produce information for tourists. However, they are very general and not related to particular supplies. Also, they are subject to free-rider problems which mean too little information is produced. But travel agents also provide information. A travel agent recommends various tourist packages (hotels, transportation, tours, etc.) based on information they have acquired. Hence they are effectively selling the information they have produced. The only question is whether the free-rider problem shows up here. The answer would appear to be that there is little free-riding. In order for free-riding to be a concern it must be that the information created can easily be shared with others freely. This seems unlikely with travel agents simply because the information any one customer has is on a particular location (e.g. Oman) and the only way to share that information is if the customer knew someone who happened to want to go to Oman. While this is possible, it seems sufficiently unlikely that free-riding is not a concern for travel agents.

Thus one conclusion is that travel agencies exist to reduce the costs of asymmetric information.