adverse selection

noun

Definition of adverse selection

economics

: a market phenomenon in which one party in a potential transaction has information that the other party lacks so that the transaction is more likely to be favorable to the party having the information and which causes market prices to be adjusted to compensate for the potential unfavorable results for the party lacking the information

Note: An example of adverse selection is the used-car market in which the seller knows more about the true condition of the car than the buyer, providing incentive to attempt to sell vehicles that are in worse condition than they appear, thus lowering the overall price buyers are willing to pay for used cars. Another example is the health insurance market in which the buyers may know more about their health problems than the insurers, providing more incentive for less healthy individuals to seek insurance, thus raising the overall price at which providers are willing to make insurance available to all buyers.