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Akerlof's Lemons and Asymmetric Information

The document discusses asymmetric information which occurs when one party to an economic transaction has more knowledge than the other. It describes the lemons problem referring to issues that arise from asymmetric information between buyers and sellers. It also discusses adverse selection and moral hazard as types of asymmetric information problems and how the financial system helps mitigate the effects of asymmetric information.

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Shozab Ali
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38 views2 pages

Akerlof's Lemons and Asymmetric Information

The document discusses asymmetric information which occurs when one party to an economic transaction has more knowledge than the other. It describes the lemons problem referring to issues that arise from asymmetric information between buyers and sellers. It also discusses adverse selection and moral hazard as types of asymmetric information problems and how the financial system helps mitigate the effects of asymmetric information.

Uploaded by

Shozab Ali
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd

Assignment

Name: Shozab Ali Asad

Reg no: FA19-BAF-123

Section-B
Asymmetric Information:

Asymmetric information, also known as information failure, occurs when one party to an
economic transaction possesses greater material knowledge than the other party. In economic
transaction there are two types of parties the seller and buyer. In transaction seller always has
more information than buyer, and hence causes Asymmetric information. Asymmetric
information is seen as a desired outcome of a healthy market economy in terms of skilled labor,
where workers specialize in a trade, becoming more productive, and providing greater value to
workers in other trades.

Lemons problem:

The "lemons problem" refers to issues that arise due to asymmetric information possessed by
the buyer and the seller. The lemons problem was first put forward in a research paper, "The
Market for 'Lemons': Quality Uncertainty and the Market Mechanism," written in the late 1960s
by George A. Akerlof, an economist and professor at the University of California, Berkeley.
The tag phrase identifying the problem came from the example of used cars Akerlof used to
illustrate the concept of asymmetric information, as defective used cars are commonly referred
to as lemons.

Adverse selection And Moral Hazard

Adverse selection occurs when there's a lack of symmetric information prior  to a deal between a
buyer and a seller. Moral hazard is the risk that one party has not entered into the contract
in good faith or has provided false details about its assets, liabilities, or credit capacity.

Mitigation of Asymmetric Information:

One of the major functions of the financial system is to tangle with those devilish information
asymmetries. It never kills asymmetry, but it reduces its influence, intermediaries by screening
insurance and credit applicants and monitoring them thereafter, and markets by providing price
information and analysis.

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