Final answer:
The presence of asymmetric information in a perfectly competitive market can lead to market failure because it distorts the price mechanism, making it unable to reflect the true marginal benefit to the buyer and marginal cost to the seller.
Step-by-step explanation:
Asymmetric information between buyers and sellers can lead to market failure in an otherwise perfectly competitive market because it can prevent the market from reaching an efficient outcome. The correct answer to the question posed by the student is C: If the buyer and seller have different information about the transaction, the price will not reflect either the marginal benefit to the buyer or the marginal cost to the seller. When there is asymmetric information, one party has an informational advantage over the other, which can lead to adverse selection—where the party with less information cannot accurately determine the value of a good or service, or to moral hazard—where one party's behavior is hidden and may change to the detriment of the other party. This information gap can reduce the quality of goods on the market, as sellers with poor quality goods are more likely to participate if the buyers cannot distinguish quality. This situation can diminish the overall trade in the market and result in a market failure, as high-quality goods may be driven out due to lack of consumer confidence in their ability to ascertain quality.