Topic 2.10 · HL only
Market failure: asymmetric information: notes and practice questions
Summary
- This topic examines asymmetric information as a market failure where one party in a transaction has more or better information than the other.
- Asymmetric information leads to inefficient market outcomes.
- Adverse selection occurs when hidden information before a transaction leads to undesirable outcomes.
- Moral hazard arises when one party takes on more risk after a transaction, with costs borne by the other.
- Responses include government legislation, regulation, and information provision.
- Private responses involve signalling (informed party reveals) and screening (uninformed party elicits).
How it is examined
HL Paper 1 and Paper 3 territory. Adverse selection and moral hazard are clean 2-mark defines, and the AO3 responses row supports a 15-mark part (b) on whether government or private responses work better. It cannot carry a diagram question, because the guide requires no diagram for it.
Guiding questions
- What happens when one side of a transaction knows more than the other?
Linking questions
- Imperfect information is also listed as a limitation of rational consumer choice in 2.4, and both are HL only.
- Provision of information is an intervention tool shared with 2.7 and 2.8.
Practice questions
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Where marks are lost
- No real-world example, or a stated one. An answer that names a country and stops cannot reach the top two bands.
- One-sided argument. Balance is an explicit axis. A student who argues only that a policy works is capped at 9 out of 15 on that axis alone.
- Diagram present but not explained. The diagram bullet escalates across three bands: included, included and explained, included and fully explained. A diagram dropped into an answer without prose that refers to it sits at 5 to 6 on a 10-mark part.
