15 Asymmetric Information

The buyer needs a hundred eyes, the seller not one.

—George Herbert (1651)

Learning Objectives

  1. Explain why adverse selection prevents desirable transactions.

  2. Describe the methods used to reduce adverse selection.

  3. Show how moral hazard decreases gains and distorts risk sharing in economic transactions.

  4. Construct contracts that reduce or eliminate moral hazard.

  5. Explain how monitoring can reduce moral hazard problems.

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