Week 7 Assymetric of Information - EBS2023 Information...

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EBS2023 Information Economics Lecture 7 Information Asymmetric Faculty of Economics & Business Universiti Malaysia Sarawak
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Chapter 17 2 Topics to be Discussed Quality Uncertainty and the Market for Lemons Market Signaling Moral Hazard The Principal-Agent Problem Managerial Incentives in an Integrated Firm Asymmetric Information in Labor Markets: Efficiency Wage Theory
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Chapter 17 3 Introduction We can see what happens when some parties know more than others – asymmetric information Frequently a seller or producer knows more about the quality of the product than the buyer does Managers know more about costs, competitive position and investment opportunities than firm owners
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Chapter 17 4 Quality Uncertainty and the Market for Lemons Asymmetric information is a situation in which a buyer and a seller possess different information about a transaction The lack of complete information when purchasing a used car increases the risk of the purchase and lowers the value of the car Markets for insurance, financial credit and employment are also characterized by asymmetric information about product quality
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Chapter 17 5 The Market for Used Cars Assume Two kinds of cars – high quality and low quality Buyers and sellers can distinguish between the cars There will be two markets – one for high quality and one for low quality
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Chapter 17 6 The Market for Used Cars High quality market S H is supply and D H is demand for high quality Low quality market S L is supply and D L is demand for low quality S H is higher than S L because owners of high quality cars need more money to sell them D H is higher than D L because people are willing to pay more for higher quality
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Chapter 17 7 The Lemons Problem P H P L Q H Q L S H S L D H D L 5,000 50,000 50,000 10,000 D L Market price for high quality cars is $10,000. Market price for low quality cars is $5000. 50,000 of each type are sold.
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Chapter 17 8 The Market for Used Cars Sellers know more about the quality of the used car than the buyer Initially buyers may think the odds are 50/50 that the car is high quality Buyers will view all cars as medium quality with demand D M However, fewer high quality cars (25,000) and more low quality cars (75,000) will now be sold Perceived demand will now shif
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9 The Lemons Problem P H P L Q H Q L S H S L D H D L 5,000 50,000 50,000 10,000 D L Medium quality cars sell for $7500, selling 25,000 high quality and 75,000 low quality. The increase in Q L reduces expectations and demand to D LM . The adjustment process continues until demand = D L . D M 25,000 7,500 75,000 7,500 D M D LM D LM
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Chapter 17 10 The Market for Used Cars With asymmetric information: Low quality goods drive high quality goods out of the market - the lemons problem The market has failed to produce mutually beneficial trade Too many low and too few high quality cars are on the market Adverse selection occurs; the only cars on the market will be low quality cars
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Chapter 17 11 Market for Insurance
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