7. How asymmetric information prevents gains from trade Aa Aa Maria sees a class

Question

7. How asymmetric information prevents gains from trade Aa Aa Maria sees a classified ad offering a used lawn mower for $20. On the opposite page, she sees a big color ad from a national home improvement chain offering a new lawn mower for $300. Maria values a lawn mower at $400 as long as it works, regardless of whether it is new or used. Suppose Maria buys the new lawn mower from the national home improvement chain, thinking, "Someone would ask $20 for a used lawn mower only if it didn't work well." This reasoning reflects concerns that the market may be characterized by which principle? Adverse selection O The free-rider problem Government failure O Moral hazard Suppose Robert, the seller of the lawn mower, knows the mower is in good condition-he is only selling t has decided to replace his lawn with a new deck. He thinks about asking $40 and offering a guarantee: He will Robert, the seller of the lawn mower, knows the mower is in good condition-he is only selling it because he place the lawn mower with a new $300 lawn mower 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, she can pretend it didn't work and get a new lawn mower for $40-meanwhile, IlI be out $2601" Robe concerns related to which principle? rt's line of reasoning regarding his potential buyer illustrates O The free-rider problem O Moral hazard O Government failure O Adverse selection

Explanation / Answer

A) Answer of the first question is Adverse selection. This is because due to having more information about a product he can buy the perfect one.

B) Answer of the second question is Moral hazard,this is because moral hazard occurs under a type of information asymmetry where the risk-taking party to a transaction knows more about its intentions than the party paying the consequences of the risk. More broadly, moral hazard occurs when the party with more information about its actions or intentions has a tendency or incentive to behave inappropriately from the perspective of the party with less information.

C) Moral hazard can prevent sellers from offering guarantees of quality because they can't be sure that buyer's won't try to take advantage of the guarantees by filling false claims.

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