This is the graded finale for the whole course. It pulls the entire arc together: asymmetric information and Akerlof’s used-car model, where an honest average price drives out the peaches and the market unravels toward lemons; the general shape, where the very fact that someone is willing to trade with you is itself bad news about the deal; the arenas where hidden type bites — insurance death spirals, credit rationing, labour-market lemons, online marketplaces and dating, IPOs and disclosure; the cures that rebuild trade — signalling, screening, and third-party institutions and mandates; and the sharp line dividing adverse selection (hidden type, before the deal) from moral hazard (hidden action, after it). Along the way it plants deliberate traps drawn from the most common misreadings — that adverse selection means sellers are lying (it doesn’t), that it’s just moral hazard by another name (it isn’t), and that you can fix it by “just paying the average” (you can’t) — so read each stem carefully before you lock in an answer. Imagine walking onto a lot where every peach is priced like a lemon: that $8,000 offer on a genuinely great car is exactly the move that starts the rot.
How this exam works
This is a final, one-way exam. Questions come one at a time, and submitting an answer locks it for good — there is no going back, no retry, and no restart. Your score stays hidden until the very end, when you will see whether you passed. The pass mark is 70%. Some questions are marked select all that apply and need every correct option checked (and no wrong ones) to earn the point. Take your time on each question, because you only get one shot at it.
What is "asymmetric information", the engine underneath the whole course?
Select an answer to continue.
Course Recap
Big picture
Adverse Selection & the Lemons Problem — the whole course
- Adverse Selection & the Lemons Problem
- The used-car model
- Buyers cannot tell peaches from lemons, so they hedge to an average price; that price is below what a peach is worth to its owner and above what a lemon is worth, so peaches withdraw and lemons stay.
- Each departure lowers the true average, so the buyer's next offer falls and drives out the next tier of good cars — the market unravels round by round toward lemons, a failure with no villain and no dishonesty required.
- The willing counterparty
- Hidden information about TYPE selects who is willing to trade, so the very fact a deal is offered to you, at this price, is itself bad news — always ask "why is this being offered to me?"
- It is a cousin of the winner's curse: both come from conditioning on a selection event, so "just pay the average" fails because any average price repels the cars worth more than it and sinks the real average below your offer.
- Where it strikes
- Insurance death spirals (the sick buy most, so premiums rise and the healthy exit), credit rationing (a higher rate selects risky borrowers, so lenders cap rates and turn applicants away), and labour-market lemons.
- Online marketplaces, dating and IPOs — same filter, many arenas; the informed side can be the BUYER (insurance, borrowing) or the SELLER (used car, home, equity issuance).
- The cures
- Signalling — the INFORMED side takes a costly, hard-to-fake, single-crossing action (warranty, brand, credential) so only good types send it; but the cost can be pure deadweight, an arms race, or exclude good-but-poor types.
- Screening — the UNINFORMED side offers a menu (deductibles, tests) so types self-select into a separating equilibrium; and institutions/mandates — inspections, ratings, mandatory disclosure, and an insurance mandate with community rating that keeps good risks in the pool.
- Transfer & honest limits
- The sharp line: adverse selection is hidden TYPE known BEFORE the deal; moral hazard is hidden ACTION taken AFTER it — confuse them and you reach for the wrong fix.
- Most markets do NOT unravel: cheap verification, reputation and repeat play, and working signals keep good types in; the model shows how a market CAN rot, not that every one must — do not over-apply it.
- The used-car model
Key takeaways — the whole course
Adverse selection is what happens when one side of a deal privately knows a fixed quality — a TYPE — that the other cannot verify: the informed types keenest to trade at a given price are exactly the ones the uninformed side least wants, so the pool that shows up is selected against you. Akerlof’s used-car market is the cleanest picture — an honest average price is a bad deal for a peach and a gift to a lemon, so peaches withdraw, the average sinks, the next offer falls, and the market unravels toward lemons with no villain and no lying anywhere in it. The general habit is to treat the very availability of a deal as information (a cousin of the winner’s curse) and ask “why is this being offered to me, at this price?” — and to notice that “just pay the average” is the cause of the spiral, not the cure. The same filter bites across arenas — insurance death spirals, credit rationing, labour-market lemons, marketplaces, dating and IPOs — with the informed side sometimes the buyer (insurance, lending) and sometimes the seller (used cars, equity). The cures rebuild trade by shrinking or overriding the information gap: signalling, where the informed side sends a costly, single-crossing proof (though the cost can be wasteful deadweight); screening, where the uninformed side offers a menu that makes types self-select into a separating equilibrium; and institutions and mandates — inspections, ratings, mandatory disclosure, and an insurance mandate with community rating that keeps the good risks in. Above all, hold the line to moral hazard — hidden TYPE before the deal versus hidden ACTION after it — and stay honest about the limits: most markets never unravel, because cheap verification, reputation and working signals keep the good types trading.