Information problems and role of social networks in market mechanism

One of the most relevant and exciting issues in the latest decades in economics had been the asymmetric information and uncertainty, and their effects on market processes and efficiency. Some studies show that markets where information problems or/and uncertainty arise tend to be “networked”, and some studies propose that use of social networks can mitigate adverse selection and moral hazard problems, but this area is still under-developed. There are  numerous market situation where asymmetric information  vigorously appear (insurance or lending markets, labor markets, price discrimination…). For example firms rarely have precise information about the types of individual customers (their important features, preferences or willingness-to-pay), but can use incentive tools and screening mechanisms. Use of signaling and screening can reduce the cost of incentive under asymmetric information. We develop a model to show that social embeddedness of market players and some relevant features of their social network can be used for signaling and screening to mitigate the information problem in these markets situations. We also present an illustration on the examined problem, where we try to show the theoretical background of micro-finance groups in an economic model. In this application we examine how the social network can be used to mitigate asymmetric information problems (moral hazard and adverse selection) what characterize these lending transactions. The conclusions we draw can be generalized and can be applied to several situation where asymmetric information appears and social network has important role such as price discrimination, labor markets, micro-finance groups, online peer-to-peer lending and other online peer-to-peer markets.