Asymmetric%20Information

1
Asymmetric Information

• Perloff Chapter 19

2
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.

3
Equalising information

• Screening
• Obtaining information about hidden
  characteristics.
• Insurance.
• Costly.
• Signalling
• Use of public information to indicate the nature
  of private information.
• Restaurant.

4
Market for lemons and good cars
(a) Market for Lemons
(b) Market for Good Cars
L
S
Price of a lemon,
E
Price of a good car,
G
2,000
D
1,750
2
S
f
F


1,500
D
1,500
D
1,250
1
S
e
L
1,000
D
750
0
1
,000
1
,000
0
Lemons per year
Good cars per year
5
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.

6
Price Discrimination Through Asymmetric
Information

• Charge a different price according to willingness
  to pay.
• Some consumers may falsely believe a product is
  of a higher quality.
• Own label product.

7
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 pe.
• e is less than cost of finding another shop.

8
Monopoly price in a tourist trap

• Suppose all firms charge pe
• Same reasoning implies all firms can raise price
  to p2e
• 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.

9
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.

10
Lying to a potential employer?
11
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.

12
Pooling and separating equilibrea
13
Unique or multiple equilibrea
Pooling equilibrium
c, Cost per diploma,
c

w



w
20,000
h
l
Pooling or separating equilibrium
x
y
15,000
z
5,000
c


1






q
w



w
h
l
Separating equilibrium
1
0
1
1


4
2
, Share of high-ability workers
q