Econ_11_Main_Points_18 - Chapter 18 Main Points-1 1 For...

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Chapter 18: Main Points-1 1. For many years economists made the assumption that producers and consumers each had perfect information about prices, quantities and product quality. 2. George Stigler (1964) examined what happens in a market when information is imperfect. If information is necessary to complete a transaction, and if information has benefits, then people will engage in search behavior to generate better information. People will not have perfect information, but will search until the expected benefits (in lower prices, higher quality) are equal on the margin to the costs of additional search. 3. Stigler’s search models explain why prices vary for the same good purchased at the same time. The price paid is a monetary price, plus a search cost. “Big ticket” items such as cars have a smaller price variance relative to their mean value than low price items such as salt, because the benefits from search are greater. More search means the dispersion of prices is less.
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Chapter 18: Main Points-2 4. George Akerlof asked what would happen if one side to a potential transaction had information that the other side did not have. This asymmetric information problem could lead to a situation where a market did not exist, because information could not be reliably conveyed. 5. Asymmetric information affects 1) product quality, 2) the distribution of prices, 3) whether an equilibrium will be the same when there are differences in information, 4) possibilities for price discrimination and 5) the average equilibrium price. 6. Akerlof used the lemons problem as an example. Two types of used cars exist, good cars and lemons. Good cars are worth $2,000 to their owners. Lemons are $500 to their owners. The owners of the cars know which type of car they have. A used car dealer does not know information about any particular car, but knows the proportion of all used cars which are good, and which are lemons (say ½ and ½). What offer would the dealer make to someone who brought in a used car? The usual answer would be the average of the prices, $1,250. But in practice, no one who knew her car was worth $2,000 would accept only $1,250 for it. The equilibrium would be that the dealer would offer the lemon price, $500, and no market for good used cars would exist, because of the asymmetric information problem. 7. The asymmetric information problem leads to two other problems, adverse selection and moral
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Econ_11_Main_Points_18 - Chapter 18 Main Points-1 1 For...

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