In a market where buyers have more information than sellers, what is the likely outcome?

• A. Perfect competition, where all goods are efficiently allocated
• B. Moral hazard, where sellers take on more risk after the transaction
• C. Price discrimination, where sellers charge different prices to different buyers
• D. Adverse selection, where low-quality goods dominate the market

Answer: (D)

Verified step by step guidance

1. Understand the concept of asymmetric information, where one party in a transaction has more or better information than the other. In this problem, buyers have more information than sellers.
2. Recall that adverse selection occurs when one party uses their superior information to the detriment of the other, often leading to a market dominated by low-quality goods or 'lemons'.
3. Analyze why perfect competition is unlikely: perfect competition assumes all parties have equal information, so efficient allocation of goods is not expected here.
4. Consider why moral hazard is not the best fit: moral hazard involves one party changing behavior after a transaction due to hidden actions, which is different from the pre-transaction information imbalance described.
5. Recognize that price discrimination involves sellers charging different prices based on buyer characteristics, which does not directly relate to buyers having more information than sellers. Therefore, the likely outcome is adverse selection, where low-quality goods dominate the market.