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1、Asymmetric Information,Main topics,problems due to asymmetric information response to adverse selection how ignorance about quality drives out high-quality goods price discrimination due to false beliefs about quality market power from price ignorance problems arising from ignorance when hiring,Prob
2、lems due to asymmetric information,if both parties to a transaction have limited info, neither has an advantage asymmetric info leads to opportunism, whereby informed person benefits at expense of those with less info,Types of opportunistic behavior,adverse selection moral hazard,Adverse selection,o
3、pportunism characterized by an informed persons benefiting trading (contracting) with less informed person who does not know about an unobserved characteristic of the informed person people who buy life insurance know more about their own health than does the insurance company,Adverse selection mark
4、et failure,reduces size of a market (possibly eliminating it) example: few older people regardless of their health buy term life insurance because rates are extremely high because of adverse selection,Moral hazard,opportunism characterized by an informed person taking advantage of a less-informed pe
5、rson through an unobserved action examples sleezeball sells you swamp land in Florida employee shirks if not monitored by employer,Moral hazard not necessarily harmful,pregnant women with health insurance make more prenatal doctor visits extra cost bad for insurance firms, but society benefits from
6、healthier women and babies,Responses to adverse selection,main methods for solving adverse selection problems are to restrict opportunistic behavior equalize information,Restrict opportunistic behavior,universal coverage: provide insurance to all employees of a firm thus both healthy and unhealthy p
7、eople are covered firm buys medical insurance at a lower cost per person than workers could obtain on their own (where relatively more unhealthy individuals buy insurance),Means of equalizing information,screening action taken by an uninformed person to determine info possessed by informed people bu
8、yer test drives many used cars signaling action taken by an informed person to send information to a less-informed person firm distributes a favorable report on its product by an independent testing agency to prove its quality is high,How ignorance about quality drives out high-quality goods,buyer c
9、annot judge a products quality before purchasing it low-quality cars lemons may drive high quality products out of the market (Akerlof) owners of lemons are more likely to sell their cars, leading to adverse selection,Lemons market buyers,many potential buyers for used cars all are willing to pay $1
10、,000 for a lemon $2,000 for a good used car,Lemons market sellers,owners willing to sell up to 1,000 lemons 1,000 good used cars reservation price of owners (lowest price at which theyll sell their cars) $750 for lemons $1,250 or $1,750 for good cars,Two possible equilibrium,all cars sell at average
11、 price, $1,500 (sellers of good cars are implicitly subsidizing sellers of lemons) only lemons sell for a price equal to the value that buyers place on lemons (bad drives out good),Value to sellers of good cars is $1,250,sellers willing to sell their cars at average price ($1,500) equilibrium price
12、$1,500 in both markets lemons market equilibrium: f, intersection of SL and D* good market equilibrium: F, intersection of S1 and D* asymmetric information does not cause an efficiency problem, but has equity implications,Markets for Lemons,Markets for Good Cars,Value to sellers of good cars is $1,7
13、50,lemons drive good cars out of market buyers know that only cars they can buy at $1,750 is a lemon lemons sell for $1,000: e, intersection of SL and DL equilibrium is inefficient: high quality cars remain in hands of people who value them than do potential buyers,Lemons market with variable qualit
14、y,many firms can vary quality of their products if consumers cannot identify quality all goods sell at same price raising your quality raises average price of all firms inadequate incentive to produce high quality social value of raising the quality is greater than the private value,Limiting lemons,
15、laws to prevent opportunism consumer screening third-party comparisons standards and certification standard: metric or scale for evaluating the quality of a particular product (e.g., R-value of insulation) certification: report that a particular product meets or exceeds a given standard level signal
16、ing by firms guarantees and warranties brand name,Price discrimination due to false beliefs about quality,noisy monopoly multiple brand names refrigerators Amana and Kenmore Whirlpool and Kenmore cars Ford Taurus & Mercury Sable Toyota Camry & Lexus ES 300 Dodge Colt, Mitsubishi Mirage, Plymouth Colt, & Eagle Summit Bentley Brookland ($152,400) & Rolls-Royce Silver Spur III ($178,200),Price ignorance market power,limited information about price leads to market power consumers who do
