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1、Chapter Thirty-Six,Asymmetric Information,Information in Competitive Markets,In purely competitive markets all agents are fully informed about traded commodities and other aspects of the market. What about markets for medical services, or insurance, or used cars?,Asymmetric Information in Markets,A
2、doctor knows more about medical services than does the buyer. An insurance buyer knows more about his riskiness than does the seller. A used cars owner knows more about it than does a potential buyer.,Asymmetric Information in Markets,Markets with one side or the other imperfectly informed are marke
3、ts with imperfect information. Imperfectly informed markets with one side better informed than the other are markets with asymmetric information.,Asymmetric Information in Markets,In what ways can asymmetric information affect the functioning of a market? Four applications will be considered: advers
4、e selection signaling moral hazard incentives contracting.,Adverse Selection,Consider a used car market. Two types of cars; “lemons” and “peaches”. Each lemon seller will accept $1,000; a buyer will pay at most $1,200. Each peach seller will accept $2,000; a buyer will pay at most $2,400.,Adverse Se
5、lection,If every buyer can tell a peach from a lemon, then lemons sell for between $1,000 and $1,200, and peaches sell for between $2,000 and $2,400. Gains-to-trade are generated when buyers are well informed.,Adverse Selection,Suppose no buyer can tell a peach from a lemon before buying. What is th
6、e most a buyer will pay for any car?,Adverse Selection,Let q be the fraction of peaches. 1 - q is the fraction of lemons. Expected value to a buyer of any car is at most,Adverse Selection,Suppose EV $2000. Every seller can negotiate a price between $2000 and $EV (no matter if the car is a lemon or a
7、 peach). All sellers gain from being in the market.,Adverse Selection,Suppose EV $2000. A peach seller cannot negotiate a price above $2000 and will exit the market. So all buyers know that remaining sellers own lemons only. Buyers will pay at most $1200 and only lemons are sold.,Adverse Selection,H
8、ence “too many” lemons “crowd out” the peaches from the market. Gains-to-trade are reduced since no peaches are traded. The presence of the lemons inflicts an external cost on buyers and peach owners.,Adverse Selection,How many lemons can be in the market without crowding out the peaches? Buyers wil
9、l pay $2000 for a car only if,Adverse Selection,How many lemons can be in the market without crowding out the peaches? Buyers will pay $2000 for a car only if So if over one-third of all cars are lemons, then only lemons are traded.,Adverse Selection,A market equilibrium in which both types of cars
10、are traded and cannot be distinguished by the buyers is a pooling equilibrium. A market equilibrium in which only one of the two types of cars is traded, or both are traded but can be distinguished by the buyers, is a separating equilibrium.,Adverse Selection,What if there is more than two types of
11、cars? Suppose that car quality is Uniformly distributed between $1000 and $2000 any car that a seller values at $x is valued by a buyer at $(x+300). Which cars will be traded?,Adverse Selection,Seller values,1000,2000,Adverse Selection,1000,2000,1500,Seller values,Adverse Selection,1000,2000,1500,Th
12、e expected value of any car to a buyer is $1500 + $300 = $1800.,Seller values,Adverse Selection,1000,2000,1500,The expected value of any car to a buyer is $1500 + $300 = $1800.,So sellers who value their cars at more than $1800 exit the market.,Seller values,Adverse Selection,1000,1800,The distribut
13、ion of values of cars remaining on offer,Seller values,Adverse Selection,1000,1800,1400,Seller values,Adverse Selection,1000,1800,1400,The expected value of any remaining car to a buyer is $1400 + $300 = $1700.,Seller values,Adverse Selection,1000,1800,1400,The expected value of any remaining car to
14、 a buyer is $1400 + $300 = $1700.,So now sellers who value their cars between $1700 and $1800 exit the market.,Seller values,Adverse Selection,Where does this unraveling of the market end? Let vH be the highest seller value of any car remaining in the market. The expected seller value of a car is,Ad
15、verse Selection,So a buyer will pay at most,Adverse Selection,So a buyer will pay at most This must be the price which the seller of the highest value car remaining in the market will just accept; i.e.,Adverse Selection,Adverse selection drives out all cars valued by sellers at more than $1600.,Adve
16、rse Selection with Quality Choice,Now each seller can choose the quality, or value, of her product. Two umbrellas; high-quality and low-quality. Which will be manufactured and sold?,Adverse Selection with Quality Choice,Buyers value a high-quality umbrella at $14 and a low-quality umbrella at $8. Before buying, no buyer can tell quality. Marginal production cost of a high-quality umbrella is $11. Marginal production cost of a low-quality umbrella is $10.,
