Market Failure: Asymmetric Information
Asymmetric information occurs when one party in a transaction has more or better information than the other, leading to inefficient market outcomes. This can result in adverse selection (before the transaction) and moral hazard (after the transaction). The principal-agent problem arises when an agent acts on behalf of a principal but their interests diverge, creating inefficiency.
Key Terms & Definitions
Asymmetric Information
A situation where one party to a transaction has more or better information than the other party.
Adverse Selection
A pre-contractual problem where asymmetric information causes the market to attract disproportionately high-risk participants. E.g., insurance markets attracting unhealthy people.
Moral Hazard
A post-contractual problem where one party takes on more risk because they do not bear the full consequences of their actions. E.g., insured drivers driving more recklessly.
Principal-Agent Problem
When an agent (e.g., manager) acts on behalf of a principal (e.g., shareholder) but their interests diverge, leading to inefficiency.
Information Failure
A type of market failure where buyers or sellers make decisions based on incomplete or inaccurate information.
IB Diagram
Accurate IB-style diagram — straight lines, labelled axes
IB Diagram
Public Goods — Free Rider ProblemIB standard: straight lines · P on Y-axis · Q on X-axis · labels at end of curves · dashed drop lines to axes