What is asymmetric information? Using examples, distinguish between adverse selection and moral hazard

There are several factors that cause market failure;

a) The presence of both positive and negative externalities- consequences of both positive and negative nature where the responsible party is not charged.

b) Monopoly situation- leads to highly priced commodities

c) Provision of public goods- It is difficult to identify those who have paid for the provision of the good in form of taxes and those who have not.

d) Information asymmetry- initiates both moral hazard and adverse selection problems leading to pricing difficulties.

Information asymmetry occurs when an individual has better and more information compared to the other party and chooses to conceal this data purposely for their own advantage. When a party is involved in risky events because they know the costs associated with such actions is covered by someone else such as an insurance company, then moral hazard is evident. If a bank chooses to lend to customer with credit worthiness issues because the government has made a promise to bail them out in case of losses, this is an example of moral hazard.

Adverse selection on the other hand occurs when one party in an economic transaction has more knowledge than the other party and decides to hide this information. If an individual conceals information about a pre-existing medical illness at the time of taking an insurance cover and ends up paying less premium than they are should, this is a case of adverse selection. Information asymmetry places one party at a disadvantage due to moral hazard and adverse selection problems. Funds that could have been used for other purposes are used to mitigate this problems and to conduct frequent market research. Pareto efficiency is not attained because the consumers or sellers use the information they have at the expense of the other party.