Signals may prevent adverse selection if
A) sending a false signal is cheap for the agent.
B) sending a false signal is costly for the agent.
C) agents as rational.
D) signals are as good as cheap talk.

Question

Quizplus · Accepted Answer

Adverse selection can be prevented if the signal is costly for the agent as it makes it less likely that low-quality agents will send the same signal as high-quality agents. The cost of sending a false signal acts as a deterrent for low-quality agents, reducing the asymmetric information problem. A, C, and D are incorrect as a false signal being cheap for the agent, agents being rational, or signals being as good as cheap talk does not necessarily prevent adverse selection.

Signals May Prevent Adverse Selection If