Key Terms

Key Terms

adverse selection when groups with inherently higher risks than the average person seek out insurance, thus straining the insurance system asymmetric information a situation where the seller or the buyer has more information than the other regarding the quality of the item for sale coinsurance when an insurance policyholder pays a percentage of a loss, and the insurance company pays the remaining cost collateral something valuable—often property or equipment—that a lender would have a right to seize and sell if the buyer does not repay the loan copayment when an insurance policyholder must pay a small amount for each service, before insurance covers the rest cosigner another person or firm who legally pledges to repay some or all of the money on a loan if the original borrower does not deductible an amount that the insurance policyholders must pay out of their own pocket before the insurance coverage pays anything fee-for-service when medical care providers are paid according to the services they provide health maintenance organization (HMO) an organization that provides health care and is paid a fixed amount per person enrolled in the plan—regardless of how many services are provided imperfect information a situation where either the buyer or the seller, or both, are uncertain about the qualities of what they are buying and selling insurance method of protecting a person from financial loss, whereby policy holders make regular payments to an insurance entity; the insurance firm then remunerates a group member who suffers significant financial damage from an event covered by the policy money-back guarantee a promise that the seller will refund the buyer’s money under certain conditions moral hazard when people have insurance against a certain event, they are less likely to guard against that event occurring occupational license licenses issued by government agencies, which indicate that a worker has completed a certain type of education or passed a certain test premium payment made to an insurance company risk group a group that shares roughly the same risks of an adverse event occurring service contract the buyer pays an extra amount and the seller agrees to fix anything specified in the contract that goes wrong for a set time period warranty a promise to fix or replace the good for a certain period of time

Key Concepts and Summary

16.1 The Problem of Imperfect Information and Asymmetric Information

Many make economic transactions in a situation of imperfect information, where either the buyer, the seller, or both are less than 100% certain about the qualities of what they are buying or selling. When information about the quality of products is highly imperfect, it may be difficult for a market to exist. A “lemon” is a product that turns out, after the purchase, to have low quality. When the seller has more accurate information about the product's quality than the buyer, the buyer will be hesitant to buy, out of fear of purchasing a “lemon.” Markets have many ways to deal with imperfect information. In goods markets, buyers facing imperfect information about products may depend upon money-back guarantees, warranties, service contracts, and reputation. In labor markets, employers facing imperfect information about potential employees may turn to resumes, recommendations, occupational licenses for certain jobs, and employment for trial periods. In capital markets, lenders facing imperfect information about borrowers may require detailed loan applications and credit checks, cosigners, and collateral.