Managerial Economics and Strategy, 2/e

15.2 Reducing Adverse Selection

Because adverse selection results from one party exploiting asymmetric information about a hidden characteristic, the two main methods for solving adverse selection problems are to restrict the ability of the informed party to take advantage of hidden information and to equalize information among the parties. Responses to adverse selection problems increase welfare in some markets, but may do more harm than good in others.

Restricting Opportunistic Behavior

Which type of restriction works best to curb opportunistic behavior depends on the nature of the adverse selection problem. The government can prevent adverse selection insurance problems by mandating universal insurance coverage. The government uses a variety ...