Information Asymmetry within a Firm's Hierarchy

Asymmetric Information in Principal-Agent Problems

The Problem of Incomplete Contracts

Adverse Selection (Hidden Attributes Problem)

George Akerlof

Information Asymmetry as a Cause of Pareto Inefficiency

Inadequate Property Rights as a Cause of Externalities

Informational Barriers to Government Intervention on Externalities

In a market for used laptops, sellers know the exact condition and remaining lifespan of their device, but buyers cannot tell the difference between a high-quality and a low-quality machine before purchase. Buyers are aware that both types exist. Given this imbalance of knowledge, which of the following is the most likely consequence for the market?

Restaurant Ingredient Sourcing

Evaluating a Solution to an Information Problem in Insurance

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

The market distortions caused by an imbalance of information only arise in situations where sellers possess more relevant information than buyers.

Designing an Employment Contract to Mitigate Hidden Actions

A company hires a remote salesperson and offers them a fixed monthly salary, with no performance-based commissions. The company cannot easily monitor the salesperson's day-to-day effort. Which of the following outcomes is the most direct consequence of this information arrangement?

When an insurance company offers a policy, it cannot know for certain whether a policyholder will engage in risky behaviors after purchasing the coverage. This situation, where one party's actions post-agreement are unobservable to the other, is an example of a __________ problem.

Consider a market where sellers have perfect knowledge of their product's true quality, but potential buyers cannot distinguish between high-quality and low-quality items before a purchase. Buyers are, however, aware that a mix of qualities exists. Arrange the following events in the logical sequence that describes how such an information imbalance can cause the market to malfunction or even collapse.

Match each scenario with the specific problem caused by asymmetric information that it best illustrates.

Market Inefficiency from Information Gaps

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.

Designing a Trust Mechanism in a Digital Marketplace