Transcript Asymmetric Information - University of Reading

Asymmetric Information
Perloff Chapter 19
Asymmetric Information
• When two parties to a transaction have different
information.
• Adverse Selection
– When an informed person has an advantage through an
unobserved characteristic.
– Eg a disproportionately large number of unhealthy
people buy life insurance.
• Moral Hazard
– When an informed person has an advantage through an
unobserved action.
– An insured car driver drives faster.
Equalising information
• Screening
– Obtaining information about hidden characteristics.
– Insurance.
– Costly.
• Signalling
– Use of public information to indicate the nature of
private information.
– Restaurant.
Market for lemons and good cars
1,500
(b) Market for Good Cars
SL
f
D*
Price of a good car, $
Price of a lemon, $
(a) Market for Lemons
1,750
1,000
S2
1,500
1,250
e
E
2,000
F
DG
D*
S1
DL
750
0
1,000
Lemons per year
0
1,000
Good cars per year
Preventing the occurrence of lemon
markets
• Laws
– Product liability laws,
• Consumer screening
– The use of a mechanic,
– Reputation,
• Third party
comparisons,
– ‘Which’ reports,
• Standards and
certification,
– Kite marks,
• Signalling by firms
– Brand names to
differentiate product.
Price Discrimination Through
Asymmetric Information
• Charge a different price according to
willingness to pay.
• Some consumer’s may falsely believe a
product is of a higher quality.
• Own label product.
Tourist Trap Model
• Pure competitive market:
– All firms charge the same price.
– A higher price results in zero demand.
• Imperfect information in a competitive market.
– Know the prices charged by shops but not specific price
charged by a specific shop.
– Competitive price is p*.
– Firm can charge p*+e.
– e is less than cost of finding another shop.
Monopoly price in a ‘tourist trap’
• Suppose all firms charge p*+e
– Same reasoning implies all firms can raise price to p*+2e
• This argument can continue to be applied until all firms
charge the monopoly price.
– At this price further price increases result in a loss of profit.
• In a market where finding prices is costly the equilibrium
price is the monopoly price.
• If firms are allowed to advertise prices so that search costs
disappear the competitive price results.
Employee safety with asymmetric
information
• Employees in safer industries pay lower wages
than in unsafe.
• Safety statistics are reported at industry levels, not
the firm level.
Lying to a potential employer?
Education as a signal
• Low ability people will not graduate.
– Have to accept lower unskilled wage.
• High ability people will go to college if difference
between skilled and unskilled wage exceeds cost
of education
• Two equilibrea are possible
– Pooling
• When costs of education exceed the wage differential and
everyone is paid the same.
– Seperating
• When it pays to go to college.
Pooling and separating equilibrea
c, Cost per diploma, $
Unique or multiple equilibrea
Pooling equilibrium
c = wh – wl
20,000
Pooling or separating equilibrium
15,000
x
y
z
5,000
c——
q = 1 – ——
wh – wl
Separating equilibrium
0
1
–
4
1
–
2
1
q, Share of high-ability workers