Question

Which of the following is not true of adverse selection?

It occurs in the used-car market but not in the market for insurance.

It can result when one of the parties in a transaction has little information about the quality of the goods involved.

It drives out the high-quality products and only the low-quality products are left in a market.

It can cause the quality of the goods traded to decline if quality detection costs are high.

It can be a difficult problem to overcome because it is not individually rational for the party with more information to provide a truthful and complete disclosure.

Answer 1

Option (1) is not true.

In the used-car problem, information asymmetry gives rise to the adverse selection problem. In insurance market too, adverse selection problem ends up in insurers having a higher proportion of high-risk, health-constrained customers and a lower proportion of low-risk, healthy customers.