Market Failure: Asymmetric Information Flashcards
Define asymmetric information.
When one party in a transaction has more or better information than the other.
What are the consequences of asymmetric information?
Adverse selection and moral hazard.
What is an example of adverse selection?
In health insurance, people who are sick are more likely to buy insurance — but the insurer can’t always tell who is sick, so they may end up covering more high-risk people, raising costs.
Define moral hazard.
Moral hazard is when someone takes more risks because they don’t bear the full consequences of those risks.
Example of moral hazard.
If you have insurance, you might drive less carefully because you know the insurer will pay if something goes wrong.
What are government responses to asymmetric information?
Legislation and regulation
Provision of information - government or force firms to.
What are two private responses to asymmetric information?
Signaling
Screening
What is signaling?
The informed party shares credible info to prove their quality.
What is screening?
The less-informed party tries to gather info about the other.
