The adverse selection problem exists when an institution charges a price that encourages more high-cost customers to come in than low-cost customers.

Question

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Adverse selection occurs when there is asymmetric information between buyers and sellers, leading to a situation where higher-risk individuals are more likely to purchase insurance or a service, while lower-risk individuals opt out, due to a pricing structure that does not accurately reflect individual risk levels.

The Adverse Selection Problem Exists When an Institution Charges a Price