Asymmetric information is a problem in many markets, such as the used car market

Question

Asymmetric information is a problem in many markets, such as the used car market, the insurance markets, and the credit markets. Choose one of these three markets, and using some of the concepts you learned from this module, discuss the questions below: •What is the market response to asymmetric information? (Hint: Does Coca-Cola have an asymmetric information problem?). •What is the market response to adverse selection? (Hint: When you purchased life insurance, did you have to take a physical exam?). •What is the market response to moral hazard? (Hint: Remember last time you saw a doctor you had to pay a $30 deductible?). •Do you think that education is a "market signal" that can help companies make better economic decisions when asymmetric information exists? •What would be the market response if there was perfect information?

Explanation / Answer

The asymmetric information in the market leads to two problems-

1. Adverse Selection

2. Moral hazard

In the insurance market, to tackle adverse selection problem, one has to go through physical test as mentioned in the question. In credit markets also, the banks when lending to borrowers prepare a report on their history of paying debts to ensure that the borrower does not turn into a defaulter.

To tackle the problem of moral hazard or hidden action problem, there is co deductibility scheme where the insurers also have to contribute to the losses. This ensures that the actions are taken on part of people to prevent losses.

Yes, education acts as a market signal to companies to pay the educated higher wages as compared to uneducated.

In case of perfect information, prices reflect all the information and there is no need for such decisions.

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