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The Economist on adverse selection and moral hazard

Knowledge Problem

The Economist is running a series on classic articles that have transformed economics, starting with George Akerlof’s 1970 “Market for Lemons” paper. Akerlof catalyzed the field of information economics by pointing out possible consequences of asymmetric information in the case where one party to a transaction has more complete information about product quality than the other before the transaction takes place. In this case, symbolized by the market for used cars, buyers will be skeptical about seller assertions of product quality, fewer used cars will be sold, the cars sold will be of lower quality than in the absence of the information asymmetry, and there will be less welfare created than otherwise.

This adverse selection problem can be costly, and it’s a pervasive epistemic characteristic of life. Akerlof’s model and analysis brought those costs into brilliant focus. They also planted seeds of new ideas and new research: Michael Spence on…

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