Assignment 1: Lemon Markets
What is a moral hazard?
A lack of incentive to guard against risk where one is protected from its consequences
What qualities make external product certification useful to your market participants?
Buyers can rely on the expert verification of the quality of the seller's second hand cars
What is a market for lemons?
Issues that arise due to asymmetric info possessed by the buyer and the seller of an investment or product, regarding its value
What is adverse selection?
A situation in which sellers have info that buyers don't have and some aspect of the product quality
What's a specific mechanism that could resolve your market for lemons problem?
External product certification
What will happen in financial markets without trustworthy auditing? And why?
Financial markets wouldn't function properly because they would be missing accurate and reliable corporate disclosures and F/S. Financial markets need transparent, informative, and accurate financial reporting for consumers/investors to make informed decisions
How are adverse selection and a market for lemons related?
Market for lemons is an example of adverse selection because it shows how a market can select to exchange only lower quality products. Buyers have less accurate info about the quality of goods, so they devalue prices. This discourages sellers from marketing their higher quality goods
Give an example of a market for lemons
Second hand cars. There are good and bad quality cars
What is the essential problem in your example of your market for lemons?
There is no assurance of quality of the car and prospective buyers must make an informed guess about the car's quality. Therefore, the buyer assumes that they are not getting a good quality, so they offer a lower price than what a seller would demand for a bad quality
What are agency costs?
Type of internal cost that arises from an agent acting on behalf of principal. They arise because shareholders wish for management to run the company in a way that increases shareholder value