Adverse selection
Refers to a situation in which sellers have relevant information that buyers lack (or vice versa) about some aspect of product quality. | ||||
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Adverse Selection definition was found in categories: Social Science(1) Encyclopedia(1)
| Environmental Economics Glossary |
Adverse Selection
principle that says that those who most want to buy insurance tend to be those most at risk, but charging a high price for insurance (to cover the high risk)will discourage those at less risk from buying insurance at all When a negotiation between two people with asymmetric information restricts the quality of the good traded. This typically happens because the person with more information can negotiate a favorable exchange. This is frequently referred to as the "market for lemons." For example, let's say you're searching for a car, knowing that some are "high-quality" and others are "low-quality." However, you don't know which category a particular car is in. Suppose there's an equal chance of getting either a high-quality or low-quality car. If you're willing to pay $2,000 for a high quality car, but only $1,000 for the low quality car, how much would you offer for a given car of unknown quality? The expected value of the car is $1,500. In other words, if you bought hundreds of cars, half worth $2,000 and half worth $1,000, the average value of the cars is $1,500 each. Not knowing the quality of a given car, the price you would offer is $1,500- the average or expected price. The chance of overpaying for a low-quality car is offset by the chance of underpaying for a high-quality car. Unlike you, each owner is better aware of the quality of his or her car--they have more information than you. Your $1,500 offer would be accepted by the seller of a low-quality car, but refused by the seller of the high-quality car. Due to the lack of buyers' information, high-quality cars would not be sold. The only cars exchanged would be low-quality cars ("lemons"). Asymmetric information tends to limit quality of products exchanged, adversely selecting the lower quality cars.
principle that says that those who most want to buy insurance tend to be those most at risk, but charging a high price for insurance (to cover the high risk)will discourage those at less risk from buying insurance at all When a negotiation between two people with asymmetric information restricts the quality of the good traded. This typically happens because the person with more information can negotiate a favorable exchange. This is frequently referred to as the "market for lemons." For example, let's say you're searching for a car, knowing that some are "high-quality" and others are "low-quality." However, you don't know which category a particular car is in. Suppose there's an equal chance of getting either a high-quality or low-quality car. If you're willing to pay $2,000 for a high quality car, but only $1,000 for the low quality car, how much would you offer for a given car of unknown quality? The expected value of the car is $1,500. In other words, if you bought hundreds of cars, half worth $2,000 and half worth $1,000, the average value of the cars is $1,500 each. Not knowing the quality of a given car, the price you would offer is $1,500- the average or expected price. The chance of overpaying for a low-quality car is offset by the chance of underpaying for a high-quality car. Unlike you, each owner is better aware of the quality of his or her car--they have more information than you. Your $1,500 offer would be accepted by the seller of a low-quality car, but refused by the seller of the high-quality car. Due to the lack of buyers' information, high-quality cars would not be sold. The only cars exchanged would be low-quality cars ("lemons"). Asymmetric information tends to limit quality of products exchanged, adversely selecting the lower quality cars.
Adverse Selection Definition from Encyclopedia Dictionaries & Glossaries
| Wikipedia English - The Free Encyclopedia |
Adverse selection
Adverse selection, anti-selection, or negative selection is a term used in economics, insurance, statistics, and risk management. On the most abstract level, it refers to a market process in which bad results occur due to information asymmetries between buyers and sellers: the "bad" products or customers are more likely to be selected. A bank that sets one price for all its checking account customers runs the risk of being adversely selected against by its high-balance, low-activity (and hence most profitable) customers. Two ways to model adverse selection are with signaling games and screening games.
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