Keep the Highest: Attempts 3. How asymmetric information prevents gains from tra
ID: 1128074 • Letter: K
Question
Keep the Highest: Attempts 3. How asymmetric information prevents gains from trade Susan sees a classified ad from Raphael offering a used car seat for $20. On the opposite page, she sees a big color ad from a national retail chain offering a new car seat for $250. Susan values a car seat at $270 as long as it works, regardless of whether it is new or used For each of the scenarios listed, determine the principle illustrated by each person's reasoning. Moral Adverse Hazard Selection Scenario Suppose Raphael, the seller of the car seat, knows the seat is safe-he is selling it only because his child has outgrown it. He thinks about asking $45 and offering a guarantee: He will replace the car seat with a new $250 car seat if it turns out not to work. Then he thinks, "That's not a good idea! Someone can just buy it, handle it carelessly, and, if it breaks, can pretend it didn't work and get a new car seat for $45-meanwhile, I'll be out $205! Suppose Susan buys the new car seat from the national retail chain, thinking, "Someone would ask $20 for a used car seat only if it didn't work well.Explanation / Answer
Ans)
Scenario 1
Moral Hazard
It arises when one party has an incentive to gain on the expense of the other party.
Scenario 2
Adverse Selection
It arises when the seller has more information about a good than the buyers and thus the buyers become more apprehensive that they might be buying a lemon.
Moral Hazard can prevent sellers from offering guarantees of quality because they cant be sure that buyers won't try to take advantage of the guarantees by filing false claims.
Adverse selection can cause buyers to avoid purchasing high-quality goods because of the uncertainty about their quality.
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