Question

Adverse selection is present when?

1) There are different types of individuals and it is difficult to tell the different types apart
2) The marginal cost of the last unit is higher than the marginal benefit
3) A particular contract changes incentives for behavior for some people
4) There are large external benefits

Answer 1

Adverse selection is present when there are different types of individuals and it is difficult to tell the different types apart due to their inherently higher risks. This can happen in situations such as purchasing health insurance.

Step-by-step explanation:

Adverse selection is present when there are different types of individuals and it is difficult to tell the different types apart. This is because individuals with inherently higher risks than the average person tend to seek out insurance, which strains the insurance system. For example, someone purchasing health insurance may know more about their family's health history than an insurer can reasonably find out, leading to adverse selection.