Transcript L25
L25
Asymmetric Information
Road map
1) 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 the patient.
2. Insurance: 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”
Second hand car market.
Types of cars: “lemons” and “plums”.
Lemon
Plum
Seller
1000
2000
Buyer
1200
2400
Benchmark: Perfect information
Gains-to-Trade (50% - 50%)
Asymmetric information
Lemon
Plum
Seller
1000
2000
Buyer
1200
2400
Asymmetric information (50% - 50%)
Gains-to-trade and BS, SS
Separating equilibrium
Lemon
Plum
Seller
1000
2000
Buyer
1200
2400
Asymmetric information ( , 1 )
Pooling equilibrium
Lemon
Plum
Seller
1000
2000
Buyer
1200
2400
Asymmetric information ( , 1 )
Gains-to-trade BS and SS
Adverse Selection
Separating equilibrium 1/ 3
“too many” lemons “crowd out” the plums from the
market.
gains-to-trade are reduced since no plums are traded
Bad for plum owners
1/ 3
Pooling equilibrium
Lemon owners “hide behind” the plums
Somewhat bad for plum owners
Pareto efficiency
Probability of “bad type” is high: compulsory insurance
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 h 1 (a plum)
- low-ability manager has productivity a l 0 (a lemon)
Fraction of high-productivity managers 1/ 2
w E (a | I )
Competitive markets
Benchmark: No signal (pooling)
Equilibrium with signaling
Signal: MBA education
Managers can chose the level of education
Cost of education (MBA)
For high-ability worker education costless
l
l
l
For low-ability worker c (e ) 0.2e
el , e h
c (e ) 0
h
h
Benefit of education
MBA has no effect on workers’ productivities
Talent not observed but MBA diploma yes - signal
It is a deadweight loss
Q: Is there a separating equilibrium with signaling?
a 1,
h
Can
(Non) Credible signal
a 0,
l
c (e ) 0,
h
h
we separate with e=2?
c (e ) 0.2e
l
l
l
a 1,
(Non) Credible signal
h
Credibility
a 0,
l
condition
c (e ) 0,
h
h
c (e ) 0.2e
l
l
l
a 1,
h
Can
A credible signal
a 0,
l
c (e ) 0.1e ,
h
h
h
we separate now?
Signal
more costly to low type
Deadweight loss (burning money)
Common in real world: adds
c (e ) 0.2e
l
l
l
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).
Moral hazard
Perfect information: full insurance
Asymmetric information:
- partial insurance
- contract that depends on output
To assume proper incentives