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4. Explain the “lemons problem” in terms of financial instruments and the role of financial intermediaries...

4. Explain the “lemons problem” in terms of financial instruments and the role of financial intermediaries in reducing this problem. You are NOT to answer this question referencing the automobile market.

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Answer #1

Lemon problems is the problem due to price or valuation of goods due to asymmetric information between buyer and sellers. It is prevalent in insurance industry and credit market. Eg. If the health insurance does not have complete information of health of the customer they might charge lower premium even if the customer has serious health disorder. This can create problem for insurance industry.
Financial intermediaries not only collect information but also inform customers regarding all the risk and hence customers take an informed decision thereby reducing lemon problem.

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