Adverse selection (逆向选择)

Adverse selection (逆向选择 nìxiàng xuǎnzé) is a problem caused by asymmetric information when one party has more or better information than the other party. An example is “the market of lemons” raised by George Akerlof. In a used-car market, the seller knows the real quality of the car while the buyer is uninformed. Due to the uncertainty, the buyer tends to offer a medium price. The cars worth more than average price eventually exit the market, leaving only cars with low quality. The result is a market failure, i.e. bad cars drive out good ones.

Part 1: Breakdown of Words

• “Adverse” (逆 nì) as in adverse balance (贸易逆差 mào yì nì chā). Here adverse (逆向 nìxiàng; 逆 nì, contrary; 向 xiàng, direction) is similar to reverse, which means the opposite.
  • “逆” (nì) as in “rebel” (叛逆 pàn nì), “adverse balance of trade” (逆差 nì chā), or “violate” (违逆 wéi nì).
  • “向” (xiàng) as in “direction” (方向 fāng xiàng), or “vector” (向量 xiàng liàng).
• Adverse (不利 bù lì) as in an adverse effect (不利影响 bùlì yǐngxiǎng), which means negative, unfavorable, or harmful and is different from the adverse in adverse selection.
• “Selection” (选择 xuǎn zé) as in “natural selection” (自然选择 zì rán xuǎn zé), or “alternative duty” (选择关税 xuǎn zé guān shuì).