ER / Concepts
Asymmetric Information
Created
Definition
One side of a transaction has relevant information the other side doesn’t. Imperfect information ≠ automatically market failure: it matters only when it systematically distorts incentives, selection or behaviour.
Two problems
| When | Mechanism | Example | |
|---|---|---|---|
| Adverse selection | hidden information, before the contract | insurer charges one premium → low-risk leave → average risk ↑ → premium ↑ → good trades disappear (“lemons”) | insurance, energy loans |
| Moral hazard | hidden behaviour, after the contract | one party changes behaviour that can’t be observed | utility & regulator |
How markets respond
Who moves?
Informed → signalling. Uninformed → screening.
- Signalling: the informed side acts to reveal its type (warranty, certification)
- Screening: the uninformed side designs choices so types reveal themselves (insurance deductibles, loan collateral)
- Reputation: repeated interaction makes cheating costly
Links: Market Failure