Adverse Selection

“Before an agreement, one party may know something that changes who chooses to participate.”

01 / PLAINLY

What it means, plainly

Adverse selection occurs before an agreement when private information about quality or risk changes who chooses to participate.

02 / CONTEXT

A little more

Adverse selection occurs when private information about quality or risk changes the composition of participants in a market or contract. The less-informed side adjusts terms and may drive valuable offers away.

03 / WHY IT MATTERS

Why it matters

The less-informed side may adjust terms in a way that drives away the valuable offers it hoped to attract.

04 / EXAMPLE

A familiar example

If buyers cannot distinguish reliable cars from defective ones, an average offer may push sellers of good cars out.

05 / LIMIT

What it does not mean

It is not a label for “bad” customers and does not show that every market with uneven information collapses.

06 / NOTICE

Notice it in your day

Imagine a secondhand purchase and note who knows the quality, which price the other side offers, and which verifiable signal could separate the cases.

FINAL NOTE

The idea worth keeping

Ask who knows quality before contracting and which verifiable signal could separate the cases.

QUESTIONS / 02

Questions people still have

When does adverse selection operate?

Before contracting, when uneven information changes the mix of participants.

Must every market with unequal information collapse?

No. Signals, rules, and other institutions can reduce the problem in some settings.