ECON 3P03 Lecture Notes - Adverse Selection, Moral Hazard, Nortel
19 Dec 2013
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1. 1 transactions costs: hinder the flow of funds to people with productive investment opportunities. Financial intermediaries make profits by reducing transactions cost. This activity explains puzzle #3: explaining the puzzles. Specifically, financial intermediaries reduce transaction costs: by taking advantage of economies of scale. Example: mutual funds: by developing expertise to lower transactions costs. Potential borrowers most likely to produce an adverse outcome are the most likely to seek loans and be. This problem george arerlof has shown how adverse selection influences financial structure through his famous lemons problem in the used-car market. The price of a used car under uncertainty-not knowing if the car is a peach or a lemon-is determined by the expected utility of a used car. The problem for the functioning of the used-car market is that sellers of good used cars will not sell. Sellers of lemons have a great incentive to sell.
