Alright, so now let's discuss some of the solutions to informational problems like adverse selection and moral hazard. The first solution is signaling. We might have mentioned signaling before in another video, but let's go over it again here. Signaling is an action by the informed party. The informed party is going to try and reveal their private information. They have some private information and they're going to try and reveal it to the uninformed party, to try and get rid of this information asymmetry. When we don't have the same information, it makes it a little tougher to do the transaction. So let's see how signaling can solve some of our problems here. Let's go back to that used car sale. The informed party in this case was the salesman, right? The salesman knew about the condition of the car. And when you walked in to buy the car, you didn't know that same information, right? You didn't know if it was going to be a good car or not, but what can the salesman do to signal to you that it's a good car? They can provide a warranty. If the salesman provides a warranty on the used car, now you're going to feel more comfortable purchasing it. Because if something is wrong with the car, if it ends up being a lemon, you can bring it in and they'll repair it, they'll replace it. You have this warranty, protecting you from a lemon. And this signals from the salesman too because if the salesman truly has a good car, they're going to want to provide a warranty. Because if it's a good car, they're not going to have to replace anything, they're not going to have to repair the car under the warranty because it's a good car. So the salesman, knowing they have a good car, can signal to the purchaser by offering this warranty. So the signal is the warranty that this is a good car.
How about on a job application? Let's think about a job application. The informed party in this case, when you apply for a job, they don't really know much about you. You're showing up, you just show up to the job, hey, I can make pizzas, right? Well, the informed party is the applicant. The job applicant is going to be our informed party because they know more about themselves, how hardworking they are, how good they are at their job, and their secret is how good they are. And their secret might be that hey, I'm smart. I'm a smart person. And how do we signal to employers that we're smart? We signal maybe with a college degree. By having a college degree on a resume, it signals to them, hey, they were able to get through college, they got a good degree, so they are probably smart. This college degree acts as a signal to the employer who doesn't know much about you. We're signaling to them how smart you are. So there's how signals can help relieve the problems of information asymmetry. Alright, let's pause here and then we'll continue with screening.