Question

What does the term “Asymmetric Information” mean? What is a moral hazard and what are the two groups involved? Give an example. What is meant by adverse selection? Who is involved? Give an example.

Answer 1

Asymmetric Information: It deals with the study of decisions in transactions, wherein one party has access to more or better information than others. Due to information asymmetry, the following two problems occur:

(i) Adverse selection: This implies taking the advantage of asymmetric information before transaction. One is insurer and other is insured person are involved. For example, a person may be more eager to purchase life insurance due to health problems than, someone who is healthy.

(ii) Moral hazards: This implies taking the advantage of asymmetric information after transaction. Moral hazard refers to situation where one side of market cannot observe action of the other. Insurer and insured are involved. For this reason it is sometimes called hidden action problem. For example, if someone has car insurance he may commit theft by getting his car stolen to reap the benefits of the insurance.