Adverse selection (逆向选择)

Adverse selection (逆向选择 nìxiàng xuǎnzé) is 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” ( nì) as in adverse balance (贸易逆差 mào yì nì chā). Here adverse (逆向 nìxiàng; nì, contrary; xiàng, direction) is similar to reverse, which means the opposite.
    • ” (nì) as in “rebel” (叛逆 pàn nì), “adverse balance of trade” (逆差 nì chā), or “violate” (违逆 wéi nì).
    • ” (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).
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