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Chapter 8: Q.17 (page 236)

How can the existence of asymmetric information provide a rationale for government regulation of financial markets?

Short Answer

Expert verified

Adverse selection and moral hazards are caused by the asymmetric information problem.

Step by step solution

01

Content Introduction

Asymmetric information refers to information that is not the same, therefore inconsistency occurs when there is a difference in the information offered to people that is not the actual information.

02

Content Explanation

Asymmetric information prevents a market from working efficiently or in some situations from working at all. In such situations, it becomes necessary for the government to intervene to help in efficient working of the market.

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Most popular questions from this chapter

Suppose that in a given bond market, there is currently no information that can help potential bond buyers to distinguish between bonds. Which bond issuers have an incentive to disclose information about their companies? Explain why.

What steps can the government take to reduce asymmetric information problems and help the financial system function more smoothly and efficiently?

How can asymmetric information problems lead to a bank panic?

You are in the market for a used car. At a used car lot, you know that the Blue Book value of the car you are looking at is between \(15000 and \)19000. If you believe the dealer knows as much about the car as you do, how much are you willing to pay? Why? Assume that you care only about the expected value of the car you will buy and that the car values are symmetrically distributed.

You wish to hire Ron to manage your Dallas operations. The profits from the operations depend partially on how hard Ron works, as follows

If Ron is lazy, he will surf the Internet all day, and he views this as a zero-cost opportunity. However, Ron views working hard as a “personal cost” valued at $2000. What fixed percentage of the profits should you offer Ron? Assume Ron cares only about his expected payment less any “personal cost.”
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