Difference in access to relevant knowledge.
Moral hazard: the tendency of a person who is imperfectly monitored to
engage in dishonest or otherwise undesirable behavior.
Agent: a person who is performing an act for another person (principal).
Principal: a person for whom another person (agent) is performing an act.
• Employers can respond by:
♦ Better monitoring (cameras)
♦ High wages (more incentive not to be fired)
♦ Delayed payment
Adverse selection: the tendency for the mix of unobserved attributes to
become undesirable from the standpoint of an uninformed party.
• The seller knows more than the buyer about the good sold
♦ Car market for used cars
♦ Labor market: when wages are lowered the employees that know they
are more skilled and worth more will quit
♦ Health insurance: if you are sick you have to pay more, if your healthy
you won’t pay for expensive insurance
• Invisible hand doesn’t always work
Market responses to problems of asymmetric info
Signaling: action taken by an informed party to reveal private information to a
• (Advertising, college degrees): must be costly, but less costly for the
person with the higher-quality product
♦ If they love you it is easier to pick a gift they will like
Screening: action taken by an uninformed party to induce an informed party
to reveal information.
• Asking to get the car checked, if the seller says no they know its bad.
• Insurance: driver his