Question

In September 2015, The US Environmental Protection Agency (EPA) found out that Volkswagen had intentionally programmed their diesel engines to activate some emissions controls only during mandatory laboratory emissions testing (conducted by the EPA). In other words, VW cars with a diesel engine were cheating the EPA during emissions testing. As soon as they passed the EPA test, the engine started emitting the pollutants again. There pollutants are of course a negative externality that auto companies impose on the public, and that is probably why the EPA mandates the emissions testing. But the relationship between VW and the EPA illustrates another economic problem. Define and explain this problem.

Answer 1

The problem between VW and EPA illustrates an economic problem called ASSYMETRIC INFORMATION i.e. the situation of imperfect knowledge. One side of the party has more information than the other one in the transaction. In this situation, the VW officials know that they are cheating on emissions test and once they clear the test the cars will start emitting pollutants. But EPA does not have this information and therefore will give a clean chit to VW. Hence tthere is assymetric information in this transaction.