Question

The market for used cars is:

a) active and well-functioning because of market institutions that developed to mitigate adverse selection.

b) full of moral hazards that prevent the efficient functioning of the market.

c) contains many instances of adverse selection, which prevent it from functioning efficiently.

d) exhibit the principal–agent problem that prevent buyers from knowing the quality of the car they want to purchase.

Answer 1

Asymmetric information;

When the market is not able to produce an efficient quantity, then it is said that market is failed. This might happens due to many reasons and asymmetric information is one of them. When there is an asymmetric information, then the sellers of the used car have information about it, but the buyer do not have the full information about the used car.

Since moral hazard problem arises when there is asymmetric information between two parties and there is a change in the behavior of one party after a deal has happened. On the other hand, an adverse selection problem arises when there's a lack of symmetric information prior to a deal between a buyer and a seller.

The market for used car is also known as the lemon market. So in the case of market for used car, there is asymmetric information between buyers and sellers. Hence sellers have full information about the used car but buyers do not have full information about the car.

Hence it can be said that the market for used cars is contains many instances of adverse selection, which prevent it from functioning efficiently.

Hence option c is the correct answer.