Explain the concept of adverse selection in game theory.

Explain the concept of adverse selection in game theory.

Adverse selection in game theory refers to a situation where one party in a transaction has more information about their own characteristics or behavior than the other party. This information asymmetry can lead to the party with less information making decisions based on incomplete or inaccurate information, resulting in adverse outcomes. In other words, adverse selection occurs when one party takes advantage of their superior knowledge to exploit the other party in a transaction. This concept is particularly relevant in markets with imperfect information, such as insurance or used car markets, where the seller may have more information about the quality or condition of the product than the buyer.