Economics • Economic BasicsMedium
What is meant by 'Adverse Selection' in the context of asymmetric information?
A. Consumers selecting substandard products due to misleading advertisements.
B. A pre-contractual situation where the party with more information misrepresents quality, leading to the market being dominated by undesirable outcomes.✓ Correct Answer
C. The deliberate choice of high-risk investment portfolios by conservative institutional investors.
D. Firms intentionally reducing production to drive up market prices.
💡 Solution & Explanation
Adverse selection is a pre-contractual asymmetric information problem where one party possesses hidden knowledge regarding product quality or personal risk, leading to market distortion or collapse. For example, high-risk individuals are more likely to seek comprehensive health insurance, prompting insurers to raise premiums unless regulated.
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