how asymmetric (imperfect) information can lead to a misallocation of resources, e.g. adverse selection such as in the market for used cars (lemons), and moral hazard

Question 1

Failures of Information

Answer 1

• participants in an economic exchange do not have perfect knowledge
  OR
• one participant in an economic exchange knows more than the other –> their greater knowledge is exploited
• leads to misallocation of resources –> consumers pay too much or too little –> firms product too much or too little

Question 2

Lemons Problem

Answer 2

• adverse selection - before and during economic transaction
• when buyers do not know the full extent of the quality of the product
• forced to make assumptions –> high price –> high quality –> low price –> low quality
• buying second hand cars

Question 3

Moral hazard

Answer 3

• post-transaction
• one party to an agreement engages in risky behaviour/fails to act in good faith –> knows that the other party bears the consequence of that behaviour
• insurance