l25 asymmetric information. structure of the course 1) consumers choice 2) equilibrium, producers...
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Structure of the course1) Consumers choice
2) Equilibrium, Producers
(Pareto efficiency)
3) Market Failures
- fixed cost: monopoly and oligopoly
- externalities and public goods
- asymmetric information
Asymmetric Information Assumption: full information about the
traded commodities
What about following markets? 1. Medical services: a doctor knows more
than does a patient.2. Insurance: a buyer knows more about
his riskiness than does the seller. 3. Used cars: a car’s owner knows more
about it than does a potential buyer
Problem: asymmetric information
Today
Q: how does asymmetric information affect the functioning of a market?
Important phenomena adverse selection (hidden information) signaling moral hazard (hidden action)
Market for “lemons”
Market for used cars (Akerlof 1970) Types of cars: “lemons” and “plums”. Proportion: 50% - 50%
TPS (Total Potential Surplus)
Lemon Plum
Seller 1000 2000
Buyer 1200 2400
Benchmark: perfect information
Prices (halfway):
Buyer’s and seller’s surplus
TPS and BS+SS?
Lemon Plum
Seller 1000 2000
Buyer 1200 2400
Asymmetric information
Asymmetric information (50% - 50%)
TPS and BS, SS
Separating Equilibrium
Lemon Plum
Seller 1000 2000
Buyer 1200 2400
Pooling equilibrium
Asymmetric information ( , )
Efficient outcome
Lemon Plum
Seller 1000 2000
Buyer 1200 2400
1
Adverse Selection
Separating equilibrium Lemons “crowd out” plums from the market. Surplus is reduced since no plums are traded Very bad for plum owners
Pooling equilibrium Lemon owners “hide behind” the plums Somewhat bad for plum owners Pareto efficiency (full surplus)
Probability of “bad type” is high: compulsory insurance
1/ 3
1/ 3
Signaling
Asymmetric information bad for “good” types
Incentive: Credible signal of high-quality
Examples of signals: warranties, professional credentials, references from previous clients, costly adds, education etc.
Signaling (in Labor Market) Two types of managers
- high-ability manager has productivity (a plum)
- low-ability manager has productivity (a lemon) Fraction of high-productivity managers
Competitive markets
Benchmark: No signal (pooling)
1/ 2
( | )w E a I
1ha 0la
Equilibrium with signaling
Signal: MBA education Years of education
Cost of education (MBA) For high-ability worker education costless For low-ability worker
Benefit of education MBA has no effect on workers’ productivities Talent not observed but MBA diploma yes - signal
Q: Is there a separating equilibrium with signaling?
A credible signal
Can we separate now?
Same credibility condition Deadweight loss (burning money) Common in real world: adds
Moral Hazard (hidden action)
With full car insurance are you more likely to leave your car unlocked?
With fixed hourly wage is your effort at work reduced?
Moral hazard is a reaction to incentives to increase the risk of a loss
A consequence of asymmetric information (hidden action).
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