key term - Cream Skimming

Definition

Cream skimming refers to the practice of selectively targeting the most profitable or desirable customers or market segments, while neglecting or avoiding less profitable ones. This concept is closely tied to the issues of imperfect information and asymmetric information in economic markets.

5 Must Know Facts For Your Next Test

1. Cream skimming allows firms to maximize profits by focusing on the most lucrative market segments, but it can lead to the exclusion of less desirable customers.
2. Firms engaging in cream skimming often have superior information about customer characteristics and preferences compared to their competitors or potential customers.
3. Cream skimming can exacerbate issues of adverse selection, as firms may avoid serving high-risk or low-income customers who are most in need of their products or services.
4. The practice of cream skimming can reduce overall social welfare by limiting access to important goods and services for disadvantaged or underserved populations.
5. Regulators may intervene to prevent cream skimming and ensure more equitable access to essential products and services, such as healthcare, education, or financial services.

Review Questions

• Explain how cream skimming is related to the problem of imperfect information in economic markets.
  • Cream skimming is closely tied to the problem of imperfect information because it relies on firms having superior knowledge about customer characteristics and preferences compared to their competitors or potential customers. This information asymmetry allows firms to selectively target the most profitable market segments, while neglecting or avoiding less desirable customers. The ability to engage in cream skimming is often a consequence of firms having access to more complete information about the market, which can lead to suboptimal outcomes and a lack of access to important goods and services for disadvantaged or underserved populations.
• Describe how the practice of cream skimming can exacerbate issues of adverse selection in economic markets.
  • Cream skimming can exacerbate adverse selection by allowing firms to focus on the most desirable and profitable customers, while avoiding those who are perceived as higher risk or less profitable. This can lead to a situation where the customers who are most in need of the firm's products or services, such as low-income or high-risk individuals, are unable to access them. As a result, the pool of customers that the firm serves becomes increasingly skewed towards the most profitable segments, further reinforcing the information asymmetry and the firm's ability to engage in cream skimming. This cycle can ultimately reduce overall social welfare and lead to suboptimal market outcomes.
• Analyze how government intervention and regulation can be used to address the negative consequences of cream skimming in economic markets.
  • Governments may intervene to address the negative consequences of cream skimming in economic markets, particularly in the provision of essential goods and services. Regulators can implement policies and regulations that prevent firms from engaging in cream skimming, such as requiring universal service obligations, price controls, or subsidies for underserved populations. By ensuring more equitable access to important products and services, government intervention can help mitigate the issues of information asymmetry and adverse selection that enable cream skimming. Additionally, regulators may promote greater transparency and information sharing to reduce the informational advantages that allow firms to engage in cream skimming in the first place. Through these interventions, policymakers can work to improve overall social welfare and ensure that essential goods and services are accessible to all members of society, rather than just the most profitable market segments.

Related terms

Adverse Selection:

A situation where sellers have information that buyers do not, leading to the selection of riskier or less desirable customers or products.

Moral Hazard:

A situation where one party takes on more risk because another party bears the cost, leading to suboptimal outcomes.

Information Asymmetry:

A situation where one party has more or better information than another, leading to an imbalance of power in transactions.