Lectures%2020%2B21%20Asymmetric%20Information - Asymmetric...

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1 Asymmetric Information: Adverse Selection Economics 401 Asymmetric Information ± So far everyone knew everything about the economy ± Many situations in which some market participants know more about the value of the good than others: ± Used cars ± Insurance market ± Productivity of workers ± Stock markets ± Asymmetric information causes: (1) Inefficient market outcomes (2) Market breakdown The Lemons Problem 100 buyers of used cars 100 sellers of used cars The Market Participants Everyone knows: 50 of the used cars are “good” (“plum”) 50 of the used cars are “bad” (“lemon”) Seller knows: Quality of the car he is selling Buyers cannot distinguish good and bad cars Knowledge “Seller” “Buyer” Preferences Value of a lemon Value of a plum $1000 $1200 $2000 $2400
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2 The game: ± First the seller sets price ± Then the buyer decides to purchase or not ± Buyers and sellers maximize expected value! The Lemons Problem The Lemons Problem ± Can good and bad cars trade at different prices? ± Suppose 2400 > P P > P L ± If buyer is offered a price P P he assumes it is a plum ± But: Then the owner of a lemon can set his price at P P and sell for sure because the buyer expects a value of $2400 ± Not an equilibrium ± P P = P L The Lemons Problem ± Can good and bad cars trade at the same prices?
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This note was uploaded on 04/02/2008 for the course ECON 401 taught by Professor Kuhn during the Fall '08 term at University of Michigan.

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Lectures%2020%2B21%20Asymmetric%20Information - Asymmetric...

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