Economics • Economic BasicsMedium
Which of the following describes 'Adverse Selection' in asymmetric information economics?
A. A situation where one party takes hidden risks because they are insured against negative outcomes.
B. A situation where market participants with better private information about quality unload low-quality goods or high-risk individuals buy more insurance, driving out good quality.✓ Correct Answer
C. A situation where a government policy inadvertently causes the opposite of its intended effect.
D. A situation where a firm holds monopoly power due to exclusive control over vital raw materials.
💡 Solution & Explanation
Adverse selection occurs before a market transaction when asymmetric information allows one party to exploit private knowledge, leading to outcomes like high-risk individuals disproportionately purchasing insurance. Moral hazard occurs after the contract is established when insured individuals alter their behavior due to reduced personal risk. George Akerlof famously illustrated adverse selection using the market for used cars, known as the lemons problem.
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