Adverse selection

Imagine you and your friends are having a candy trading game, but nobody can see what everyone else has. You might think that trading with everyone is equally as fun, but some of your friends might have some really good candy while others might only have bad ones. This makes it hard for you to trade fairly because you don't want to end up with bad candy.

This is kind of like what happens in the grown-up world with things like insurance or buying a used car. Adverse selection happens when one person has more information than another, about something important. For example, someone selling a used car knows everything about their car (bad or good), but the person buying it might not have that information. This could result in the buyer buying a "lemon", a car that doesn't work properly, and then regretting buying the car later.

Another example is when people buy health insurance. If someone knows they are already sick, they might buy health insurance that covers their sickness when it happens again. This is bad for the insurance company because they will have to pay out a lot of money to cover that person's healthcare. This means that the insurance company might have to raise their prices for everyone else to make up for that loss.

So, in simple terms, adverse selection means that one person knows more than another and can use that knowledge to their advantage, causing problems for the other person involved.