Managerial Economics and Strategy, 2/e

Summary

1. Adverse Selection. Adverse selection arises when one party to a transaction possesses information about a hidden characteristic that is unknown to other parties and the informed party exploits this advantage. Due to adverse selection, not all desirable transactions take place. As a result, low-quality items tend to be overrepresented in transactions, as with the lemons problem associated with used cars and many other products. Bad products may drive good products out of the market. Adverse selection creates problems in insurance markets because people with low risk do not buy insurance, which drives up the price for high-risk people.

2. Reducing Adverse Selection. Methods of dealing with the adverse selection problem include laws limiting ...