Adverse selection
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Adverse selection or anti-selection is a term used in economics and insurance. On the most abstract level, it refers to a market process in which bad results occur due to information asymmetries between buyers and sellers: the "bad" products or customers are more likely to be selected.
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Example: insurance
The term adverse selection was originally used in insurance. It describes a situation where, as a result of private information, the insured are more likely to suffer a loss than the uninsured. For example, suppose that there are two groups among the population, smokers and non-smokers. An insurer selling life policies can't tell which is which, so they each pay the same premiums. Non-smokers are less likely to die than average, while smokers are more likely to die than average. So the life policy is a better buy for the smokers. The insurance company anticipates or learns that the mortality rate of the policy holders exceeds that of the general population, and sets the premiums accordingly. The result is that non smokers tend to go uninsured though if they could buy a policy on terms that are actuarially fair given their characteristics, they would do so. So market failure is involved.
Whether examples of this sort apply in reality is an open question. Smokers may tend to reckless behaviour in general, so be relatively disinclined to insure. Or they may be in denial and not want to recognise their enhanced mortality. When the insured are less at risk than the uninsured this is known as advantageous selection.
Asymmetric information
In the usual case, a key condition for there to be adverse selection is an asymmetry of information - people buying insurance know whether they are smokers or not, whereas the insurance company doesn't. If the insurance company knew who smokes and who doesn't, it could set rates differently for each group and there would be no adverse selection. However, other conditions may produce adverse selection even when there is no asymmetry of information. For example, some U.S. states require health insurance providers to insure all who apply at the same cost. In this case, there may not be an actual asymmetry of information: the insurance company may know who is or isn't a smoker, but because the insurer is not allowed to act on that information, there is a "virtual" asymmetry of information.
The market for lemons
The concept of adverse selection has been generalised by economists into markets other than insurance, where similar asymmetries of information may exist. For example, George Akerlof developed the model of the "market for lemons." People buying used cars do not know whether they are "lemons" (bad cars) or "cherries" (good ones), so they will be willing to pay a price that lies in between the price for lemons and cherries, a willingness based on the probability that a given car is a lemon or cherry. If buyers had perfect information they would know the value of a car for certain, and they would simply pay an amount equal to the value of the car.
The sellers will sell fewer good cars since they think the price is too low, but they will sell more bad cars because they get a very good price for them. After a while, the buyers will realise this, and they will no longer want to pay the old price for a used car. The price will lower and even fewer cherries, and even more lemons, will be put up for sale. In the extreme, the cherry sellers will have been driven, as it were, out of business.
The price mechanism fails to keep the lemons off the market due to the lack of perfect information, even in an otherwise perfectly competitive market. Instead, the lemons dominate the market.
Note that despite this otherwise perfect competition the First Welfare Theorem does not hold, meaning that the resulting allocations are (usually) not Pareto optimal. The reason is that, when some traders are unable to distinguish between goods of different characteristics, markets are incomplete: goods with different characteristics are not traded in distinct markets (and therefore not at distinct prices).