Econ 2610: Principles of Microeconomics Yogesh Uppal
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Transcript of Econ 2610: Principles of Microeconomics Yogesh Uppal
Econ 2610: Principles of Microeconomics
Yogesh UppalEmail: [email protected]
Chapter 12
The Economics of Information
Information and the Invisible Hand All parties have all relevant information
Without free information, market results are not efficient Bargaining for a bowl in Kashmir
Parties must decide how much information to gather Information gathering strategies differ
$/un
itUnits of information
MB
The Optimal Amount of Information More information is better than less
Gathering information has a cost Marginal benefit starts high, then falls rapidly Marginal cost starts low, then
increases Low-Hanging Fruit Principle
Optimal amount of information is I* where MC = MB
MC
I *
Optimal
Free Rider Problem A free-rider problem exists when non-payers
cannot be excluded from consuming a good Interferes with incentives Market quantity is below social optimum
Stores bear the cost of training sales reps on merchandise Shoppers use sales reps as information source
Then some shoppers buy elsewhere Store is unable to capture some of the value it
delivered to the shopper: a free-rider problem
Gamble Inherent in Search
Additional search has costs that are certain Benefits are uncertain benefits Additional search has elements of a gamble
A gamble has a number of possible outcomes Each outcome has a probability that it will occur
Gamble Inherent in Search
The expected value of a gamble is the sum of (the possible outcomes times their respective probability) A fair gamble has an expected value of zero A better-than-fair gamble has a positive
expected value
Risk Preferences
A risk-neutral person would accept any gamble that is fair or better-than-fair A risk-averse person would refuse any fair
gamble
Asymmetric Information
Asymmetric information occurs when either the buyer or seller Is better informed about the goods in the market Mutually beneficial trades
may not occur A seller might know that
a murder was committed in a house offered for sale Buyer does not know
Private Sale of a Used Car Jane's Miata is in excellent condition
Jane's reservation price is $10,000 Blue Book value is $8,000
Tom wants to buy a Miata His reservation price is $13,000 for one in excellent
condition and $9,000 for one in average condition Determining the condition of Jane's car has a cost
and the results are uncertain Tom cannot verify that Jane's Miata is superior
The Lemons Model People who have below average cars (lemons),
are more likely to want to sell them Buyers know that below average cars are likely to be
on the market and lower their reservation prices Good quality cars are withdrawn from the market
Average quality decreases further and reservation prices decrease again
The lemons model says that asymmetric information tends to reduce the average quality of goods for sale
Your Aunt's Car
Your aunt offers you her 4-year old Accord The asking price of $10,000 is the blue book value You believe the car is in good condition
Blue book value is the equilibrium price for below average cars
You should buy the car for $10,000 It is in better condition than the average Accord of
the same vintage and mileage
Naïve Buyer Two kinds of cars: good cars and lemons
Owners know what kind they have Buyers can't determine a car's quality Buyers are risk neutral
What would the buyer offer for a used car? Expected value of a car is
(0.90) ($10,000) + (0.10) ($6,000) = $9,600 The buyer gets a lemon
Good Cars LemonsProbability 90% 10%Value $10,000 $6,000
Credibility Problem Parties gain if they find a way to communicate
information truthfully If Jane can convince Tom her Miata is in
excellent condition, Tom will buy Statements are not credible Jane offers Tom a six-month warranty on all car
defects at the time of purchase A warranty for a lemon would cost more than the
economic surplus gained Only sellers of good quality cars would offer the warranty
Adverse Selection Adverse selection occurs because insurance
tends to be purchased more by those who are most costly for companies to insure Insurance is most valuable to those with many claims
Adverse selection increases insurance premiums Reduces attractiveness of insurance to low-risk
customers "Best" insurance risk customers opt out
Rates increase Repeat
Moral Hazard Moral hazard is the tendency of people to expend
less effort protecting insured goods People take more risk with insured goods or activities Deductibles give policy holders an incentive to be more
cautious Suppose a car owner has a $1,000 deductible policy
The owner pays the first $1,000 of each claim Strong incentive to avoid accidents
Claims less than $1,000 are not reported Insurance premiums go down