Perloff_397614_IM_Ch18 - Chapter 18 Asymmetric Information...

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Chapter 18 Asymmetric Information ± Chapter Outline 18.1 Problems Due to Asymmetric Information 18.2 Responses to Adverse Selection Controlling Opportunistic Behavior Through Universal Coverage Equalizing Information 18.3 How Ignorance About Quality Drives Out High-Quality Goods Lemon Market with Fixed Quality Lemon Market with Variable Quality Limiting Lemons 18.4 Market Power from Price Ignorance Tourist-Trap Model Advertising and Prices 18.5 Problems Arising from Ignorance When Hiring Information About Employment Risks Cheap Talk Education as a Signal Screening in Hiring ± Teaching Tips Chapter 18 presents a nice opportunity to analyze some very intriguing economic questions without much need to run through a long series of mathematical relationships. Thus it can serve very effectively as a way to expose students who are either weak quantitatively or simply weary of optimization problems to areas where there is current, interesting work being done. Topics addressed in this chapter are also of great relevance today for consumers, given the changes in the health insurance industry and information technology, especially the Internet. If many of your students work full time, they will certainly be familiar with HMOs and the demise of full indemnity coverage due to adverse selection problems. Because HMOs are the most cost-effective choice for healthy individuals interested in low- or no-cost physical exams, baby care, and health club reimbursement, and traditional indemnity plans typically offer better coverage for individuals who are in relatively poor health, an adverse selection problem arises. As traditional plans become populated by individuals that are, on average, sicker than the rest of the working population (upon which actuarial tables are based), premiums must rise. The adverse selection problem then becomes even more severe as premiums rise. For this reason, traditional indemnity plans are becoming cost prohibitive, and many employers are changing their mix of offered health care plans.
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240 Perloff • Microeconomics: Theory and Applications with Calculus When discussing asymmetric information and the costs of obtaining information, an interesting application to discuss is the tourist-trap model (described in the text) in which all consumers end up paying the monopoly price even if there are many souvenir shops. This example creates a good lead into the section on advertising and prices. Students are likely to take a dim view of advertising by lawyers until you discuss the price implications. One of the most important topics in the chapter, especially if your program is labor- or industrial relations– oriented, is the section on statistical discrimination. Although not done explicitly in the text, you might want to discuss the link between statistical discrimination and dual labor market (DLM) theory. By tying statistical discrimination to DLM you can discuss the implications for two groups of workers who, even though they are perceived to have differential ability at the outset, do not. If one group of workers is
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This note was uploaded on 11/03/2009 for the course ARE 100A taught by Professor Constantine during the Spring '08 term at UC Davis.

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Perloff_397614_IM_Ch18 - Chapter 18 Asymmetric Information...

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