Asymmetric information & adverse selection

Asymmetric information is when one side of a deal knows something relevant that the other can't verify — a used-car seller who knows the car's true quality, an applicant who knows their own risk. When buyers can't tell good from bad, they will only pay a price based on average quality, which is too low for owners of the best goods, who then withdraw. That drop in average quality lowers what buyers will pay again, pushing out the next tier — a spiral called adverse selection that can unravel a market until only 'lemons' remain. The same logic strikes insurance and lending, where the riskiest customers are the keenest to sign up. The cures work by making hidden quality visible or credible: signals like warranties, certification, and reputation, or screening devices that separate the good from the bad, restoring trades that information gaps would otherwise destroy.