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We present a model for the supply-demand law with quality and limited information capability. We postulate that imperfect information permeates in almost all economic transactions to varying degrees. Through a simple model we outline a research agenda that re-examines many standard issues in economics. Our analysis shows that whereas imperfect information can be improved, it leads to new uncertainties so that the perfect information limit can never be reached. As a corollary neoclassical perfect equilibrium can never be attained.

The standard supply and demand law in economics relates price and quantity; equilibrium is achieved when the consumers’ downward demand curve and the firm's upward supply curve intersect. When Alfred Marshall more than a century ago first systematically studied the law and its applications, he used it merely as a convenient technical device [1]. Neoclassical economics since has made it the most important theoretical pillar. The core content of the supply–demand law has remained the same over the past century, in which the world economy has undergone dramatic transitions. However, products in the modern economy are much more complex a century later, and hence the capability to ascertain their quality from the consumers’ side has paramount importance in purchase decisions. In the days of Mill and Ricardo there were already vocal critiques by well-known thinkers like Charles Babbage [2] and Cliffe Leslie [3], questioning the assumption of classical economics of perfect information capability. Fast forward to 1970, Akerlof's work [4] on the ‘Lemons Problem’ clearly pointed out that strong information asymmetry about the product's quality can lead to ‘market failures’. Mutually beneficial deals between sellers and buyers may not happen, if the buyers cannot reliably determine the quality of the objects under transaction. Despite much current research on many other interesting areas of Information Asymmetry [5] and [6], the fundamental insight of Akerlof is not yet adequately incorporated into mainstream economics. In standard textbooks one encounters ‘price’ and ‘quantity’, rarely ‘quality’ is adequately modeled. In this work we shall consider an alternative version of the supply–demand law, with quality and imperfect information as the key ingredients. We consider a continuously varying degree of imperfect information, with the Akerlof ‘Lemons Problem’ as a special, extreme case. We posit that in all economic transactions, some degree of information imperfection always exists. In the modern economy, especially in affluent societies, the conduct of daily life necessitates a myriad of products and services, which become ever more complex in their visible and invisible features. On the other hand a consumer as a ‘generalist’ [18] in consumption cannot possibly spend sufficient time and resources to determine what she is buying each time. Our position is anticipated by Kenneth Arrow [7]: “Market failure is not absolute; it is better to consider a broader category, that of transaction costs, which in general impede and in particular cases block the formation of markets”.

In this paper we have presented a simple model for the law of supply–demand in the presence of imperfect information. Compared to the traditional neoclassical law we must introduce extra variables: quality and information capability of detecting it. Information is not an independent objective variable, rather it resides in the market relation of the two parties. Through this simple model we have outlined a research program that holds promise to be able to address a broad spectrum of economic issues. Our approach can be straightforwardly generalized to other areas where information asymmetry is believed to exist to some extent: like labor market, financial market etc. Whereas many results of our new approach may not seem to deviate too much from neoclassical ones, the fundamental assumption is different. We consider imperfect information as the crucial starting point and perfection can never be attained. The most relevant issue for our research agenda is not about what is the perfect equilibrium which we posit non-existent, but rather how to find better ones among imperfect situations. Many fundamental concepts so far taken for granted need to be re-examined. For instance, we must face the serious consequence that much cherished Pareto efficiency is no longer relevant in our supply–demand relations in the presence of imperfect information. This is true both for vertical as well as for horizontal search models. The maximal welfare cannot be reached. From the discussion about the pie-charts (Fig. 7) one may wonder, why is the maximal welfare solution not preferred? Would not it be rational to realize the maximal pie, then to split the extra gains between the two sides? The short answer is that if the producer and consumers are left to themselves, as in most markets, such utopian dreams are not realizable. To split the extra gains requires another market transaction, which the imperfect information impedes. Current information capability only allows that much pie to be realized as the best possible compromise, according to our model. The extra pie is beyond reach by the two sides alone. This is similar to Akerlof's Lemons Problem: the seller of a good used car and his potential buyer would end up in a mutually beneficial transaction, but the asymmetrical information prevents this transaction from happening. What can one do to improve upon the reality brought about by the ubiquitous asymmetrical information that permeates almost every aspect of our economic life? Even if we could improve information capability, the perfect equilibrium is never in sight: better information capabilities, while improving current transactions, also open up new possibilities that come with innovations. We are led to a new paradigm in which an economy will never settle in equilibrium; new and old opportunities come and go with information technology and improved information institutions. In the original paper by Akerlof, as well as by other economists, government intervention is generally called for. Licensing, certifying quality by consumers protection agencies may help to mitigate somewhat the imbalance of information. We believe there is also a new type of intervention through market force itself. The big difference between what is possible and what is realizable presents a new type of attractive business niche that entrepreneur may fill for their own profits. This business is the so-called infomediaries that can serve as a matchmaker between consumers and producers. Some prototypes have already become household names, with the advent of the Web: Ebay, Bizrate, Amazon et al. The working mechanism behind these informediaries is to tap into collective information capability of consumers, so that as if an individual consumer is suddenly empowered with much higher information capability. Elsewhere [23] and [24] we shall explore in detail how these matchmakers work to improve the information capability and the consequences.