Types of Asymmetric Information
- Adverse Selection: Occurs before a transaction. For example, a seller knows more about the quality of a product than the buyer.
- Moral Hazard: Occurs after a transaction. For instance, an insured person takes more risks because they know they’re covered.
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Consequences
- Market Failure: Markets may fail to produce efficient outcomes.
- Reduced Transactions: Fewer transactions occur, as the less-informed party may withdraw.
- Higher Costs: The uninformed party may incur additional costs for verification.
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Solutions
- Government Regulation: Ensuring transparency and disclosure.
- Signaling: The informed party takes actions to reveal information. For example, a job applicant may list qualifications.
- Screening: The uninformed party takes steps to gain more information, like background checks.
5. Real-World Examples
- Health Insurance: Companies have less information about the health risks of individuals.
- Used Cars: Sellers know more about the car’s condition than buyers.
Mark is an A-Level Economics tutor who has been teaching for 6 years. He holds a masters degree with distinction from the London School of Economics and an undergraduate degree from the University of Edinburgh.