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Distinguishing Market Problems from Information Gaps
Consider the following two scenarios:
- A company offering health insurance finds that the individuals most eager to buy its policies are those who are already facing significant health challenges, while many healthy individuals choose not to buy a policy at the offered price.
- An employee who is paid a fixed salary, regardless of output, chooses to exert less effort on their tasks than they would if their pay were directly tied to their performance, knowing their manager cannot perfectly monitor their moment-to-moment work.
For each scenario, identify the specific problem that arises from the information imbalance and explain why, focusing on whether the unobserved element is a characteristic of the individual/good or an action taken after an agreement.
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Introduction to Microeconomics Course
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A key problem in economics occurs when one party in an interaction has more or better information than the other. This can lead to two distinct issues based on whether the information is hidden before or after an agreement is made. Match each scenario below to the specific problem it best illustrates.
Distinguishing Market Problems from Information Gaps
Match each scenario with the specific problem caused by asymmetric information that it best illustrates.
A person who obtains a comprehensive car insurance policy may subsequently be less cautious about where they park their car or how they drive, knowing that the financial costs of theft or an accident are largely covered. This scenario is a primary example of adverse selection.
Insured Driver's Risky Behavior