Where there is asymmetric information between buyers and sellers, which of the following is most likely to occur?

• A. No transactions will occur because buyers and sellers have identical information
• B. Sellers will always offer warranties to eliminate information asymmetry
• C. Adverse selection, where low-quality goods are more likely to be sold than high-quality goods
• D. Perfect competition, where all goods are sold at their true value

Answer: (C)

Verified step by step guidance

1. Understand the concept of asymmetric information: it occurs when one party in a transaction has more or better information than the other, often leading to market inefficiencies.
2. Recognize that when sellers have more information about product quality than buyers, buyers may be unable to distinguish between high-quality and low-quality goods.
3. Identify adverse selection as a key outcome of asymmetric information, where low-quality goods are more likely to be sold because buyers are unwilling to pay premium prices without assurance of quality.
4. Note that warranties can sometimes reduce information asymmetry but are not always offered or sufficient to eliminate the problem entirely.
5. Conclude that adverse selection explains why markets with asymmetric information often fail to allocate resources efficiently, leading to a prevalence of lower-quality goods being sold.