up:: Content
author:: Sudan Aryal
full title:: The Economics of Asymmetric Information
url: Link
Highlights
- Market failure refers to a situation where free markets fail to achieve pareto optimal outcome
- exogenous uncertainty; lack of perfect foresight about events that might occur outside the economic system
- information asymmetry; a special case of imperfect information caused by an imbalance between two negotiating parties in their respective knowledge of relevant factors
- Second Fundamental Theorem of Welfare dictates; as long as markets remain competitive, pareto efficiency can be achieved with any redistribution of initial wealth
- The planner wants to tax highly-able taxpayers and give transfers to those of low ability and at the same time ensure that the tax policy does not incentivize those of high ability to mask themselves as being of low ability
- Such situations where worse risks (lemons) crowd out the good risks (plums) from the market is called adverse selection.
- moral hazard happens because of ex-post information asymmetry (
- example, a person might choose to care less about their health because they’ve got an insurance.