Information, Uncertainty & Signals
Screening: How the Uninformed Side Finds Out
How insurers, lenders and employers design choices and tests that lead people to reveal hidden information about themselves.
When one side of a market knows more than the other, the less informed side is not helpless. It can design tests and choices that encourage people to reveal information. Economists call this screening. Joseph Stiglitz, who shared the 2001 Nobel prize, did important early work on it.
Tests and checks
The simplest form of screening is a direct check. Lenders look at credit histories and income records. Employers run interviews, skills tests and reference checks. Insurers ask health questions. Each reduces the information gap directly.
Menus that make people sort themselves
A cleverer form of screening offers a menu of contracts and lets people choose. Because different types of people prefer different options, their choices reveal who they are. This is called self-selection.
Insurance offers a clear example. An insurer might offer two car insurance policies: one with a low deductible, the amount you pay yourself before insurance covers the rest, and a high price; another with a high deductible and a low price. Careful drivers, who expect few claims, tend to choose the cheap policy with the high deductible. Riskier drivers prefer the expensive policy with more coverage. The insurer learns about risk without asking directly.
Airlines sell cheap tickets that require booking weeks ahead and cannot be changed, alongside flexible tickets that cost far more. Business travellers, who often book at short notice and need flexibility, usually buy the expensive tickets. Leisure travellers, who plan ahead, choose the cheap ones. The ticket rules screen customers by how much they are willing to pay.
Limits
Screening has costs. Tests can be expensive, and menus of options often leave some people with less coverage than they would like, because the options must be unattractive enough to stop the wrong people choosing them. Screening can also raise fairness concerns if it relies on characteristics people cannot control, which is why many countries restrict what insurers and employers may ask.
Screening and signalling both deal with hidden information, but they differ in who acts. In signalling, the informed side, such as a job applicant, takes action to prove something. In screening, the uninformed side, such as an employer or insurer, designs tests or choices to find out.
- Screening is how the less informed side of a market uncovers hidden information.
- Direct checks include credit histories, interviews and health questions.
- Menus of contracts lead people to reveal their type through their choices.
- Screening differs from signalling, where the informed side acts to prove something.
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