Critically discuss two mechanisms of your choice used in practice to deal with the problem of...

Critically discuss two mechanisms of your choice used in practice to deal with the problem of adverse selection.

Expert Solution

Adverse Selection refers to the absence of symmetric knowledge between the buyers and sellers whereby either of them can possess better and more information than the other. In this case there are possibilities that one can exploit the other. The mechanisms that I prefer to deal with adverse selection are:

i) Bear some cost for gathering additional information when the full information is not available. This might actually save me from buying a defective policy or product. Therefore, if the cost of the information is less than the loss incurred from buying the defective product then it is rational to bear the cost.

ii) Again adverse selection can arise when suppose a company hires employees. If the company is offering a modest wage then often people with less skill will readily apply and the high skilled workers may not apply. In this case it is optimal for the company to offer higher wages so that high skilled workers are employed.

Rahul Sunny answered 1 year ago

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