Market Failure: Asymmetric Information (DP IB Economics: HL)

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After the 2008 financial crisis, governments worldwide introduced stricter regulations on financial institutions. These regulations were designed to reduce moral hazard, ensuring that banks do not take excessive risks under the assumption that they will be rescued in the event of failure.

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In the context of insurance, adverse selection refers to the tendency of riskier individuals to seek coverage, while moral hazard describes how insured individuals may take more risks knowing they are protected. Both create challenges for insurance providers as more insurance claims can reduce their profitability.

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In job recruitment, candidates often rely on signalling to highlight their qualifications, while employers use screening to evaluate potential employees through interviews and background checks. These processes reduce uncertainty in hiring decisions.

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The Australian government’s recent initiative to ensure transparency in the banking sector has led to many advantages. By requiring detailed disclosures on investment products, the government aims to address asymmetric information and help consumers with their decision-making.

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The French government has mandated that food products carry more information indicating their nutritional content. This effort is part of a larger strategy to address asymmetric information, giving consumers the tools they need to make more informed dietary choices.

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Many insurance providers have faced rising costs as a result of adverse selection, where high-risk individuals disproportionately seek out coverage. This has led to some companies struggling in certain segments of the market.