2.10 Market Failure: Asymmetric Information (DP IB Economics: HL): Flashcards
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Define asymmetric information.
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Cards in this collection (13)
Define asymmetric information.
Asymmetric information exists when buyers and sellers have different levels of information about a good or service, distorting market outcomes and causing market failure.
Define symmetric information.
Symmetric information exists when buyers and sellers have exactly the same level of information about a good or service, one of the assumptions of a free market.
What is the classic real-world example of a market with asymmetric information?
The classic example is the used car market, where sellers know more about the vehicle than buyers do.
True or False?
Asymmetric information means the buyer always has more information than the seller.
False.
Asymmetric information means one party has more information than the other; depending on the market it may be the seller (used cars) or the buyer (insurance).
How does asymmetric information cause market failure?
It distorts socially optimal prices and quantities, leading to the over-provision or under-provision of goods and services.
Define adverse selection.
Adverse selection occurs when the party with more information has an advantage in knowing their own risk profile, such as high-risk individuals being more motivated to buy insurance.
Adverse selection can force insurers to raise to compensate for a higher-risk pool of customers.
Adverse selection can force insurers to raise premiums to compensate for a higher-risk pool of customers.
Define moral hazard.
Moral hazard occurs when one party is protected from risk and so takes more risks than they would if fully exposed to the consequences.
What is an example of moral hazard following the 2008 recession?
Banks continued to make high-risk decisions because they knew the government would bail them out if they failed.
Define signalling.
Signalling is a strategy used by the party with private information to convey that information to others, such as a used car seller offering a checklist of the car's condition.
True or False?
Signalling and screening are private responses to asymmetric information.
True.
Both are actions taken by private firms or consumers without government intervention to reduce information failure.
Define screening.
Screening is where buyers gather information to assess the quality or reliability of sellers, such as reading reviews or relying on trusted third-party certifications.
What are the two government responses to asymmetric information?
The government can use legislation and regulation and the provision of information.
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