EC260 Lecture Notes - Lecture 11: Adverse Selection, Perfect Information, Used Car
Document Summary
Lesson 3. 3: adverse selection: the market for lemons. Lemon: used car that turns out to have lot of problems not apparent at time of purchase. Famous paper by ackerlof: describes market for used cars as market for lemons; points out that disproportionate number of lemons turn up in used car market. This is because of information asymmetry between buyers/sellers. Only seller knows true quality of car buyers won"t pay more than average quality in market. Market for lemons is example of market failure information asymmetry hampers existence: adverse selection in automobile insurance. Adverse selection: describes major problem that arises in market for insurance. Insurers categorize divers according to type of vehicle, location, age, and gender, and using statistics about accident rates to determine expected loss from each customer, and charge premiums accordingly. This can still result in differences in risk among policyholders that have been slotted in same category.
