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Adverse Selection (Hidden Attributes Problem)
Missing Market due to Asymmetric Information
A missing market occurs when a potentially beneficial exchange fails to happen because of asymmetric or non-verifiable information. [1] Adverse selection is a key cause of such missing markets; for instance, in a 'lemons' market where buyers cannot assess quality, the information gap can cause the market to collapse entirely as no cars are offered for sale. [1]
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Adverse Selection in Health Insurance
The Market for 'Lemons' (Adverse Selection in the Used Car Market)
Missing Market due to Asymmetric Information
Adverse Selection in Labor Markets
Identifying Adverse Selection Scenarios
A company starts offering an optional, premium warranty for its electronic devices at a fixed price. The warranty covers any and all repairs for three years. After one year, the company finds that it is losing a significant amount of money on this warranty program because the repair costs for the customers who bought it are far higher than anticipated. The company concludes that only the customers who are rough with their devices or suspect their specific device might have underlying issues were willing to pay the extra price for the warranty. Which economic principle best explains this outcome?
Rental Market Dynamics
Freelance Platform Pricing Strategy
Loan Market Interest Rate Policy
Adverse selection occurs in a market when one party changes their behavior in a risky way after entering into a contract, because they are no longer fully bearing the negative consequences of their actions.
In the classic economic example of the used car market, an information imbalance between buyers and sellers creates a specific type of market problem. Match each abstract component of this problem to its corresponding description in the used car market context.
A market is characterized by an information imbalance where sellers know the true quality of their goods, but buyers do not. This can lead to a negative outcome for the market as a whole. Arrange the following events in the logical order that describes how this problem unfolds.
When a market fails because one party in a transaction has private information about pre-existing, unobservable characteristics that the other party lacks, the resulting problem is known as ______. This can cause the quality of goods or the risk profile of participants remaining in the market to become undesirable from the uninformed party's perspective.
Evaluating Solutions to Adverse Selection in Insurance
Hiring Challenges in a Tech Startup
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Government Provision of Unemployment Insurance as a Response to Missing Markets
Uninsurable Risk of Poor Academic Performance
The Market for High-Skill Artisans
A company wants to hire freelance graphic designers for a critical, high-stakes project. The company cannot accurately assess a designer's true skill level before hiring them, only after the work is complete. They offer a fixed, generous hourly rate to all applicants. Despite many designers applying, the company finds that the quality of work from those they hire is consistently below their expectations, and they ultimately cancel the freelance program. Which of the following best explains this market failure?
The Market for Academic Insurance
True or False: A private market for insurance against receiving a poor grade in a college course fails to exist primarily because the potential financial losses for students are not significant enough to warrant creating such a product.
The 'Lemons' Problem and Market Collapse
An insurance company wants to sell individual health insurance policies. The company cannot verify an applicant's complete health history or future health risks, but each applicant knows their own health situation well. Match each economic phenomenon to its description in the context of this market.
A market for a specific type of product is failing. Arrange the following events in the logical sequence that explains how an information imbalance, where sellers know the product's true quality but buyers do not, can lead to the complete disappearance of this market.
When buyers in a market cannot distinguish between high-quality and low-quality products, while sellers are aware of the true quality, the price buyers are willing to pay may fall so low that sellers of high-quality goods exit the market. In the most extreme case, this information imbalance can cause the entire market to fail to exist, a situation known as a(n) ________ ________.
A commercial bank is considering offering loans to new tech startups. The bank cannot reliably distinguish between startups with a high probability of success and those with a high probability of failure. The startups, however, have a much clearer understanding of their own potential. If the bank sets a single interest rate for all startup loans that reflects the average risk of the entire applicant pool, what is the most likely long-term outcome for this specific loan market?
Overcoming Information Gaps in Specialized Markets