Adverse Selection

The result of asymmetric information. Information is asymmetric when all participants in a market do not have the same amount of material information. Adverse selection occurs when poor-quality participants or goods in a market are treated much more favorably because of skewed or unbalanced information. Adverse selection creates price distortions in the market.

Consumer perception of market products based on adequate information will drive prices down for goods that are likely to perform poorly (be a lemon) or create disutility. Poor-quality and high-quality goods will not be traded at proximate prices, and there will be little or negligible price discrimination because of information asymmetry.

Adverse selection is a risk-based theory in which consumers take risks because of lack of information. Sellers of low-quality products are well disposed to sell their products, but sellers of high-quality products are not necessarily so. The net effect is that both good- and poor-quality products are perceptibly misconstrued to reflect price expectation.