Question

Give an example of a situation that led (or could have) to adverse selection in real estate and logistics company in pricing department

Answer 1

Adverse selection arises when there is asymmetric information between the buyer and the seller which leads to market failure. Thus when the buyer knows more than necessary, and is pricing the product differently than the seller than there is adverse selection problem.

Thus in the case of real estate when the seller prices a product at a cheap rate in an expensive locality, the buyer will think that he/she is getting the property at a bargain and is influenced, thereby willing to buy the product. But the seller might be in need of cash and the property could have been completely dilapidated which the buyer is not aware of, and realises after he/she has signed the contract. When landlords try to advertise the product online, by showcasing good pictures and selling it at cheaper rates, and the student after signing the contract realises that the place has several health hazards in place. Remax is one such firm wherein agents earn commissions and if they are expected to retire or leave their jobs and turn self employed they decide to take in a lower commission from the customer, so as to gain a customer base, but the customer doesn't know that.

In the case of logistics, the supplier can sign a contract with a buyer at a reduced rate and sell products, but the quality may not be the same and the buyer has no other choice but to accept the product as he/she has signed a contract. This will lead to market failure and the buyer not being able to sell the final product to the customer ultimately, which will harm the future transactions. Thus Fed ex receives several packages which are destroyed and in order to prevent adverse selection it outright rejects such packages in order to prevent asymmetry.