Practice Calculations P. 421, Chapter Essay

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Under the first scenario, the ideal price point is only the maximum profit point for children, but it not for adults.

Chapter 11, p. 449, Q2.

An adverse selection problem is defined in the textbook as "a situation resulting from asymmetric information in which parties may not come to an agreement on a transaction because of distrust on the part of the party with incomplete market information…" in the scenario presented, the credit card company would normally set credit rates based on the creditworthiness of the customer. Because the credit card company cannot do this, it must find a price point that will allow it to generate a profit commensurate with the risk it undertakes.

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The problem is that consumers with good credit may find these rates unpalatable if they know their own worth in the credit markets. Good consumers may therefore avoid the credit card companies, leaving only the bad consumers. The rate decision made by the card company is adverse because it is not pricing according to market conditions, a function of its asymmetrical information. This costs it customers it would otherwise want to have.

Credit card companies can try to lessen the impacts of this problem in two ways. The first is that the company can offer different rates based on credit scores, or based on past credit history. This buys….....

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