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Information Asymmetry, Taxicabs and Zillow

NEW YORK (TheStreet) -- When one party has access to more or better information than another, it can difficult for the the two parties to come to an agreeable and efficient market outcome. Just think about how much power used-car salespeople and stock brokers have lost over the past 10 to 20 years. It's tough for the Wolf of Wall Street to sell you stock in shell company XYZ when you can Google search it. Information asymmetry has plagued trade economics and the spread of ideas for tens of thousands, if not hundreds of thousands of years.

Fortunately we live in an era today where information asymmetry is being studied carefully and we have the most powerful tool for spreading information the world has even seen, the internet. Today we'll look at one example of how a party with inferior information can elicit favorable behavior from another and how Zillow (Z - Get Report) has become one of the hottest stocks on the market by divulging information that was previously held by a small group of people.

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When a passenger jumps in a taxicab, there is often a flat charge of $2 to $3 in addition to per mile and per minute fees. The flat charge can be a bit of an annoyance too as it often constitutes a significant portion of the total fare. But when a rider is uninformed on key information like the roads, traffic patterns, or is traveling in an unfamiliar city, the upfront charge quietly becomes the rider's best friend.

Let's face it, passengers are often subject to a huge information asymmetry barrier with cab drivers. Without the the flat fee cab drivers would love to take their unsuspecting passengers on an nice long ride making sure to go out of the way to hit all the most congested roads within a reasonable distance of the most efficient route. Here's where the flat fee comes into play.

The flat charge paid to get in a cab becomes a game changer by changing the economic incentives that the driver faces. Instead of long hauling everyone who hops in the car, cab drivers can now make more money by getting riders from point A to point B as quickly as possible. With flat fees in place the driver's incentive becomes to turn over as many customers as possible because each time he or she does there is another flat fee to be collected.

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