Adverse Selection
Adverse selection is a phenomenon that occurs when buyers and sellers have asymmetric information. It is a type of market failure that occurs when buyers and sellers have different levels of information about the product or service being exchanged. This can lead to an inefficient market outcome, as buyers and sellers may not be able to accurately assess the value of the product or service being exchanged. Adverse selection can lead to higher prices, lower quality products, and a lack of trust between buyers and sellers.
History of Adverse Selection
The concept of adverse selection was first introduced by George Akerlof in his 1970 paper, “The Market for Lemons”. In this paper, Akerlof argued that when buyers and sellers have asymmetric information, it can lead to an inefficient market outcome. He used the example of the used car market, where buyers and sellers have different levels of information about the quality of the car. Akerlof argued that this could lead to a situation where buyers are unwilling to pay a fair price for a car, as they are unable to accurately assess its quality.
Since Akerlof’s paper, the concept of adverse selection has been widely studied in economics and finance. It has been used to explain a variety of phenomena, from the pricing of insurance contracts to the behavior of financial markets.
Table of Comparisons
| Type of Market | Adverse Selection |
|---|---|
| Used Car Market | Buyers and sellers have different levels of information about the quality of the car. |
| Insurance Market | Insurers have more information than policyholders about the risk of a claim. |
| Financial Markets | Investors have different levels of information about the value of a security. |
Summary
Adverse selection is a phenomenon that occurs when buyers and sellers have asymmetric information. It is a type of market failure that can lead to an inefficient market outcome, as buyers and sellers may not be able to accurately assess the value of the product or service being exchanged. Adverse selection was first introduced by George Akerlof in his 1970 paper, “The Market for Lemons”, and has since been widely studied in economics and finance. For more information about adverse selection, please visit the websites of the Federal Reserve Bank of St. Louis, the World Bank, and the International Monetary Fund.
See Also
- Asymmetric Information
- Moral Hazard
- Signaling
- Market Failure
- Information Asymmetry
- Principal-Agent Problem
- Akerlof’s Lemons
- Insurance Risk
- Financial Risk
- Market Risk
