Economics • Economic BasicsHard
Which of the following describes 'Adverse Selection' in asymmetric information markets?
A. A situation where policy makers select the wrong macroeconomic tool to combat inflation
B. A market process where undesirable or high-risk participants are more likely to self-select into a transaction due to asymmetric information before the contract is made✓ Correct Answer
C. The deliberate choice of monopolists to restrict output and raise prices above marginal cost
D. The tendency of commercial banks to lend only to prime corporate borrowers during economic downturns
💡 Solution & Explanation
Adverse selection arises in markets featuring asymmetric information before a contract is finalized, where high-risk individuals or inferior products disproportionately seek participation. Options describing macroeconomic policy errors or purely monopolistic pricing strategies refer to entirely different economic phenomena. The classic illustration of this market failure is George Akerlof's study of the market for used cars, famously known as lemons. Insurance markets frequently battle adverse selection when unhealthy individuals buy more coverage than healthy ones.
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