Question

1. Explain what is meant by asymmetric information.

2. Explain whether each of the following situation involves adverse selection and moral hazard or not:

i) I am financing a new car. In applying for a loan, I withhold information about my student loan, and the loan does not show up on my credit report. (2.5 marks)

ii) Just before quitting my job, I take out all the credit cards I can. I plan to run them up to the5 limit and declare bankruptcy. (2.5 marks)

iii) I take out a loan to manufacture a product. My costs end up being higher than expected, and there seems to be little market for my product. I am unable to repay the loan on time.

Answer 1

Assymetric information occurs when one party to an economic transaction possess greater material knowledge than the other party.

almost all economic transactions involves information assymetries.

two types of assymetric information are adverse selection and moral hazard.

Here there are three cases ,

1. in this case we can see a adverse selection as no proper information is not dislosed and that will result in undesirable result. so defenitely here there is a adverse selection happening which is a type of assymetric information.

2. In the scenario we can see the person doing a act which is a moral hazard as he takes the risk becaus he knows that he is protected due to another individual bearing the risk. sio we can see a clear moral hazard happening here.

3.Here is another scenario ,In this we can clearly see a adverse selection because the individual takes loan for a manufacturing without having proper knowledge or information about the business or manufacturing which he is going to do. we can see a worst result due to his wrong decision. It is a adverse selection as it makes an undesirable result due to limited or incorrect knowledge

so these are the assymetric information happening for each scenarios.