Overview: Problems of Information and Risk

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Economists have argued since Adam Smith that markets tend to be efficient, that the "invisible hand" works. However, they have discovered that the conditions needed for a whole economy to be economically efficient are so restrictive that they will not in practice happen. All buyers and sellers must be price takers. Information must be good and equally available to buyers and sellers. Private-property rights must exist and be complete. When these assumptions are not satisfied, the market can fail to allocate efficiently.

This group of readings considers how markets are affected when information is poor, when buyers and sellers have unequal information, and when uncertainty about the future creates risk. These problems yield unintended consequences that shape the way economists understand an exchange economy. The readings conclude a glance at auctions with structures that people are best advised to avoid.

After you complete this unit, you should be able to:

  • Define and give examples of screening, signaling, speculation, arbitrage, hedging, entrepreneur, moral hazard, and adverse selection.
  • Explain what the entrapment game is and why situations of this sort should be avoided.
  • Explain two ways of coordinating economic decisions.
Copyright Robert Schenk