Chapter EMC, Problem 2FRQ

To determine

The problem created by asymmetric information, how it causes market inefficiency, and the remedy of the problem when individuals or corporations believe that the government will bail them out if they make decisions that cause a financial collapse.

Explanation of Solution

This kind of problem will be the problem of incomplete markets because banks or home-buyers think that the government will release them easily from any event that can cause a financial collapse in the economy. Because in this case banks or home-buyers can adopt the wrong financial decision which can be beneficial for them but would lead to economic or market failure in the economy of the country. Therefore, it is a market incomplete problem.

This situation will lead to market inefficiency because when wrong financial decisions are made such as high-interest rates or unreasonable registration fees, then it will reduce the income of people. This, in turn, leads to low consumption which causes market inefficiency.

The problem of market incomplete can be sorted out by recognizing the available instruments, which can reduce the risk of market inefficiencies such as government intervention which can restrict the power of the financial institution and regulates the guidelines or rules which are necessary to follow.

Economics Concept Introduction

Introduction: There is an information imbalance which is called asymmetric information when one party to a financial transaction has better or more information than the other party and uses that information to their advantage. This leads to market failures in the economy, such as adverse selection.