Adverse Selection
Market Failure: Asymmetric Information
AO2·HL
Syllabus requirement
A form of asymmetric information where the uninformed party gets systematically disadvantaged (e.g. insurance markets).
Assessment objectives
AO2 Application and Analysis
Higher LevelThis topic is assessed at HL.
Summary
This topic explains adverse selection and moral hazard as two types of market failure that arise from asymmetric information. Adverse selection occurs when buyers and sellers have unequal information, causing high-risk or low-quality participants to dominate a market; moral hazard arises when one party insulated from risk behaves less carefully. Both problems distort prices, quantities and lead to inefficient market outcomes, so they matter for understanding why markets sometimes fail and when government or institutional responses are needed.
