Appraising Information

A farmer reaps and sows their fields with a tractor. Over twelve years of good use, the tractor eventually breaks. With their hands-on but limited mechanical skills, neither the farmer nor their neighbors are able to fix it. The farmer calls every mechanic within a day's drive but they say “it’s too far out”. The farmer considers transporting the tractor to the nearest mechanic but the trailer is too small. The farmer chooses to park the tractor on the side of the road and places a sign on it saying “make me an offer!”. To the farmer, the tractor has no value.

A mechanic is traveling through the countryside and stumbles on the farmer's tractor. They inspect it and they know exactly the $50 piece that would make it work. The mechanics labour to fix the machine would cost them $250 and transporting it out would cost another $200. But, a working tractor could sell for $5000.

The mechanic approaches the farmer. By knowing the farmer's occupation, the mechanic deduces that the broken tractor likely has no utility to the farmer. With this in mind, the mechanic offers the farmer a menial $1. It’s true, the farmer has no use for the broken tractor but prior to being a farmer they worked on a scrap yard. They know the scrap metal itself is worth $1200 and transporting it out would cost $200. The farmer is patient and it costs them nothing to store the broken tractor on their property. Someday a scrapper will pass by and the farmer will sell it to them for $999! And, the scraper will buy it because they will still make a profit of $1 even after paying to transport the broken tractor to the scrap yard. With this in mind, the farmer, not knowing they are dealing with a mechanic and not a scrapper, offers the tractor for $999.

The mechanic shakes the farmer's hand and agrees to the deal. The tractor is sold for $999. The farmer is elated. A useless tractor has netted them a handsome sum. After transporting the tractor, procuring the necessary piece and labouring over the tractor, the mechanic sells it for $5000! This nets the mechanic $3501 a sum far greater than the farmer’s profit.

Trade is adversarial. The farmer’s profit was the sale price. On the other hand, the mechanic’s profit was the difference between $4500 and the sale price. A lower sale price benefits the mechanic at the expense of the farmer and a higher sale price benefits the farmer at the expense of the mechanic.

To reveal personal information costs and to conceal identity pays. From the start of the negotiation, the tractor was bound to sell for some amount between $1 and $4499 inclusive. But, the mechanic knew the farmer's occupation. They used this information to their advantage and correctly deduced the broken tractor was useless to them. If the farmer had known their counterparty was a mechanic, they could have approximated the mechanics relative value for the tractor. With this in mind, the farmer would have made a much higher counter offer.

It pays to know about your counterparty and it costs for them to know about you.