What is adverse selection?

Adverse selection refers to a situation in which sellers have information that buyers do not have, or vice versa. This asymmetric information can then be exploited. Asymmetric information, also called information failure, occurs when one party to a transaction has greater material knowledge than the other, typically about product quality.

Can adverse selection'shut down' a market?

Akerlof’s model shows that adverse selection can potentially ‘shut down’ a market, such as the market for used cars. Agan and Starr’s paper provides evidence that banning the box had the effect of ‘shutting down’—or at least substantially harming—the job market prospects of minority applicants.)

How does adverse selection affect the secondhand car market?

In the secondhand car market, a seller may know about a vehicle’s defect and charge the buyer more without disclosing the issue. The general consequence of adverse selection is that it increases costs since consumers lack information held by sellers or producers, creating an asymmetry in the market.