Adverse selection
When the better informed side decides whether to take part, the ones who accept an offer are the ones it suits the offerer least.
Often misread asBlaming the bad outcome on sellers lying or buyers being gullible, when in the standard story nobody lies and nobody changes their behaviour.
How to see it
Hidden type: the terms you offer decide who turns up
Adverse selection is a problem before any deal is made. The informed side knows something fixed about itself, such as its health or the quality of its car, and decides whether the offered terms are worth accepting. Terms priced for the average attract the worse than average, which makes the pool worse, which makes the fair price worse again. The market can shrink or disappear entirely.
The checkEveryone can be honest and passive. All that is needed is that the informed side is allowed to decline the offer.
Try itTake the used-car market and remove every form of dishonesty: sellers never misdescribe anything and buyers judge correctly what they can see. Sellers simply keep their good cars when the going price is low. Check whether the market still unravels. It does.
Games that show it
Know these first
Easily confused with
Sources
- Akerlof, G. (1970). Quarterly Journal of Economics 84(3), 488-500.
- Mas-Colell, A., Whinston, M. & Green, J. (1995). Oxford University Press.