wk 1 - Info Asymmetry and role of Banks Flashcards
What is Asymmetric Information?
Information that is not equal or even
What does asymmetric information lead to
Inefficient outcomes
What is adverse selection
A situation where undesirable results occur due to an imbalance of information in a transaction
How does adverse selection and moral hazard affect economies
- The Lemons Problem
- The principle agent problem
What is The Lemons Problem
Market failure arising from asymmetric information about a P/S. Good and bad products become mixed and buyers become unwilling to pay a fair price
What is the Principle Agent Problem?
The problem of motivating the agent to act in the best interests of the principle
When does adverse selection occur?
Before the transaction
How can you combat Adverse Selection?
- Information Collection
- Government Regulation
- Screening
How does information collection reduce adverse selection
Reduces uncertainty and information asymmetry
What negative externality arises from information collection?
Free-rider Problem:
A situation where some people benefit from a G/S without paying
How does Gov. Regulation reduce Adverse Selection
Can ensure more information is released to increase transparency
What is Screening
A strategy to combat Adverse selection where the agent attempts to filter out false information
What is Moral Hazard
One party takes on excessive risk because another party will bear some of the burden
what is moral hazard in insurance
Where a party’s behavior changes because they feel protected from the risk by insurance
e.g.
Less attentive to precautions
Over consumption
How can moral hazard occur in lending
When a borrower engages in risky behaviors that are not in the best interest of the lender:
e.g.
Not repaying loan when able to
Using the loan for risky activities (lottery ticket)
Providing false info (about assets, credit, etc)
