Question

1. Recognizing the existence of asymmetric information

Complete the following table by determining which economic problem is characterized in each of the scenarios provided.

Scenario	Adverse Selection	Moral Hazard
When Ginny didn't have renter's insurance, she was very careful not to leave candles lit in her apartment and locked the door when she left. Now that she has renter's insurance, she typically leaves candles burning all day and forgets to lock the door because she knows that, even if her apartment catches on fire or gets broken into, her insurance will cover it.
Kenji would like to buy a used plasma television, but he is not an electronics expert and, thus, cannot assess the quality of a TV directly before owning it. Kenji believes that owners of the worst TVs are more willing to sell their TVs than owners of the best TVs. Because of this, Kenji believes that used TVs up for sale are probably of low quality.

Answer 1

When two parties has asymmetric information about any event, where one party prevails over other party due to asymmetric information in the negotiation which result one party is getting undue advantage over other party. This type of situation is called Adverse Selection.

Moral Hazard situation arises when one party deliberately misleads or suppresses the information or deliberate actions that cause to increase the risk of other party.

In first scenario,

In normal circumstances, Ginny uses all necessary steps to minimize her own risk. As she taken insurance, where now risk of any damage or loss to the property is borne by Insurance Company. In this situation, she deliberate actions like leaving candles burning or leave unlock door, causes to increase the risk of other party that is Insurance Company. This situation is Moral Hazard.

In second scenario,

Here Mr. Kenji is buyer and has some generalized perception about seller's behavior. In this situation, one party has some information of about other party and based on this information Mr. Kenji try to negotiate with seller. This situation is Adverse Selection.