Markets with Adverse Selection
Consider a market in which products of varying quality are exchanged. Both buyers and sellers rank products of different quality in the same way, but only the sellers can observe the quality of each unit of the good they sell. Buyers can observe at most the distribution of the quality of the goods previously sold. Without some device for the buyers to identify good products, bad products will always be sold with the good products. Such a market illustrates the problem of adverse selection.
KeywordsInterest Rate Equilibrium Price Credit Rationing Adverse Selection Average Quality
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