AP Economics Mr. Bernstein Module 79: The Economics of Information January 2016

AP Economics Mr. Bernstein Private Information: Adverse Selection The Economics of Lemons The seller of a used car has More information about its true condition than the buyer Fear of buying a lemon reduces price for all used cars Reduced prices keeps nicer cars off the market Buyers respond by using screening methods (ie Carfax) Sellers of higher quality used cars signal their private information via reputation or otherwise Who is most likely to become that guy? That lady? 2

AP Economics Mr. Bernstein Private Information: Adverse Selection The Economics of Insurance The buyer of health insurance knows of existing risky conditions Fear of selling to sickly person raises price for all used persons Higher prices keep healthier people out of the market Insurers respond by using screening methods (ie no previous conditions allowed) Can government laws/subsidies change this? 3

AP Economics Mr. Bernstein Private Information: Moral Hazard An individual has information about their own actions but others bear cost or risk for lack of care or effort Example: Not purchasing smoke alarms after buying fire insurance Example: Banks lowering mortgage lending standards because they assumed they were “too big to fail” and would receive gov’t bailout Solution: Requiring a deductible gets some “skin in the game” 4