Alright now, let's see the role that information plays in economic transactions as well as the problems that information can pose. So to this point we've been assuming because we haven't even really talked about it. We've assumed that everyone had complete information, right? Complete information. Well, that's a state of being fully informed. Okay. So right now, we haven't really talked about information. So we just assumed everyone kind of knew everything that was going on in the real world. Obviously that's a little different, right? We have what's called private information. And that's when you know something that others don't know, right? Private information, knowing something others don't know. And this leads to a situation called information Asymmetry. And that's the situation where one party, well, they no more, one party knows more than the other party in the transaction. Okay. So I have some examples here and then we're gonna break them into the actual informational problems, uh, leading up. So let's see some examples right here. First, we have dr and car insurance. So drivers may be less cautious when they have car insurance. Right? So once you get the insurance policy, you might think, hey, I'm covered, You know, maybe I'll run this red light and nothing will happen if I get in a crash, I'm gonna get a big payout. So they're gonna drive less cautiously. They're changing their behavior, um, because they have car insurance, right? How about a used car salesman? Well, used car salesman knows more about the car that they're selling, right? They know more about the used car than the person purchasing it. That's why there's always been a problem in the used car market and there's this reputation of buying a used car and you might get a lemon right. We call lemons a bad car and last one here, a patient might know more. They're also gonna know more patients, no more than the insurance company about their health condition, right? You might have some information about your health, but you didn't specifically portray when you got the health insurance, right? But in the back of your head, you had it sitting there as a reason you wanted health insurance, right? So let's go ahead and pause here and in the next videos, we're going to talk about adverse selection and moral hazard. The two informational problems. Let's check it out.

Alright. So, let's start with the first of the two informational problems. And that is adverse selection. So, adverse selection is when you enter into agreements where you can use private information to your advantage. Okay. You're gonna use this private information, You have some private information and you're gonna use it to your advantage. And this this adverse selection. It relates to un observable characteristics, things that you couldn't find out just by looking, right, Un observable characteristics and it occurs before a transaction. Okay. And this is key. This is the key determination between adverse selection here and moral hazard. The next topic we're gonna talk about. So, I'm gonna put in this box over here. I wanna put before, because this is key to remembering which one is adverse selection and which one is moral hazard. I struggled with this for a long time. But if you just remember adverse selection happens before moral hazard happens after, that's a really good way to remember. Okay, so let's start here with some examples. So, let's go back to that used car sale. Right? We had that situation where we have the used car salesman, the salesman knows a secret, right? The salesman is going to know a secret about the used car and that's the condition of the car, right? The car's condition only the salesman knows that you you walk up into the shop and you see the used car, but you don't really know any anything about it. So, what's gonna happen in this used car market? There's kind of this reputation where you're gonna buy a used car and it's gonna have all these problems, right? And there's gonna be what's called a lemon, Right? This becomes the idea of a lemon problem where you're gonna buy a car and then it's not gonna work, Right? So, what happens is that you don't end up buying a car because you don't know enough about the car and you're not gonna want to buy it under these conditions. So, there's no sale right now, what makes matters worse is that since you already have a distaste for these used cars because of this lemon problem? Well, your willingness to pay for a used car goes down, Right? So, this is almost like self reinforces the issue, right? Because when your willingness to pay for a used car goes down, well, the amount of good cars, the amount of good used cars left is also going to go down, right? At this lower price point, it's more likely that you're gonna get a lemon when you're willing to pay less for the car. So, that even makes the the adverse selection even worse here, Right? The secret of knowing the condition of the car leads to no sale because you don't know enough about the car as the buyer. All right. So, let's look at this other example with health insurance on the right? So, we we mentioned this above as well, where the patient knows more about their own health than the insurance company, right? So who knows the secret here, I'm gonna say the patient and this is the person buying health insurance. Right? So this is before the transaction and the secret is that they know about their health problems, Right? Let's say they have some health problems. They know about them and the insurance company does not. Alright. So what ends up happening is that since everyone buying insurance might have these health problems that they're not bringing to the table? Well, the result is that we have a riskier health pool. Riskier um insurance pool, Right. The people who are insured are riskier than they said they were or that we knew them to be because they have these secret health problems and that's what caused them to go by the health insurance. So how does this problem make it even worse? Well, when the insurance company sees all these claims being made and they have to pay out all this money, well, they got to cover it somehow and they're gonna increase the premiums, right? And if they increase the premiums, well, that's a bad thing for the healthy people, write the healthy people might now look and say, man, these premiums are going up, I don't really use the insurance that much. They might just drop it altogether. Right? So the healthy policyholders are gonna go down and what happens then, since there's low less healthy people, there's only the riskier people left now, right, There's only the people with health problems in the insurance claim. So now you're making the problem even worse here. Right. So this is the idea of moral excuse me, of adverse selection where there's these secrets before the transaction is made, um, that can't be revealed right away. Right. So, we're gonna talk about also how we solve these informational problems. But up front, these are the problems that we need to deal with. Right? There's these secrets and they're causing a problem that doesn't allow the economic transaction to happen. All right, So now let's go on to the next one. Moral hazard. Let's talk about that in the next video.

Alright, so let's continue here with moral hazard. So remember adverse selection is before the transaction. Right? So moral hazard. Well this is a party to a contract, altering his behavior after a contract is made. So now we've made a contract together and we're gonna change our actions after the contract, Right? So when we talk about moral hazard, we're gonna talk about a principle and an agent. This is a relationship between two people where the principal is the person who entrust someone, being the agent, the principal entrust the agent with a task. Okay? So the principle is going to trust the agent with a task usually by paying them something, the principal's gonna pay the agent and the agent will do something on their behalf. But that's not all cases, but that's generally the way to think about it, the principal and trust the agent with a task. Well and the agent is the person who carries out the task on someone's behalf, right? Being the principal. So they're kind of interrelated here, right? The principal and the agent they go hand in hand. So let's see a couple examples before we do that. Let's fill in this box here. This is the important box right here. So uh adverse selection was before moral hazard happens after the transaction. Okay, So let's check it out. Let's see a couple examples. So the employer employee relationship. Right? So you can think about when someone gets a job and he's making pizzas right? Well the principle is going to be the employer, right? The employer is the principal and the agent is the employee right? The employer is having the agent do this task on their behalf, Make the pizzas on their behalf. So what's the moral hazard here? The moral hazard is that the employer can't really watch the employee all the time. Right? There's not gonna be perfect monitoring where they're just over his shoulder, making sure he's making pizzas every second of every day. Well, the moral hazard is that the employee can start slacking off, right? If he's not being uh properly motivated or properly monitored, he could be slacking off right when the employer is not looking and that is him changing his behavior after the contract. Right now we've signed the contract, he got hired. He said he was gonna be this great employee who's gonna do all these, make all these awesome pizzas. But now when you're not looking, he's over there texting on his phone or something, right? So he'll be slacking off. That is the moral hazard there. Let's look at this insurer insured relationship. So in this case it's a little more abstract to think about principal and agent. But let's think about the principle here being the insurance company. So the insurer is the principal and the task that they're putting on to the agent is just to be the same person they were before. So let's think about car insurance. Um, well in the case of car insurance, the insurer expects the insured person to drive just as they would whether they had no car insurance. If you think about if you had no car insurance, you'd probably be pretty cautious. You don't want to get into a wreck, You're gonna stop at every yellow light, right? Make sure that your car is safe and the But once you get insurance right? Well, you might drive a little less cautiously, right? You're gonna say, well, maybe I can take this yellow or if someone hits me, I'm gonna get a big payout. So you don't take all the precautions that you might take when you didn't have insurance, Right? So you're gonna be a little less wary and you're gonna have a low effort to prevent losses, right? Because you're insured, you're not gonna care as much and you're gonna change your behavior, right? You might drive a little riskier after you got the car insurance than you did before. Alright, So that's the moral hazard there. Is that both these cases, the employee and the insured person, they're changing their behavior after the transaction is made. Okay? So that's the moral hazard average selection was before the transaction. Cool. Let's go on and move on to the next video. Now