Lecture19 - Lecture!#19 INFORMATION ECONOMICS INFORMATION...

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INFORMATION ECONOMICS Lecture #19 ASYMMETRIC INFORMATION So far in our studies we have neglected to examine the issues raised by differences So far in our studies we have neglected to examine the issues raised by differences in information. Up until now, we assumed that both buyers and sellers were perfectly informed about the quality of the goods being sold in the market. This assumption can be appropriate if it is easy to verify the quality of an item. We can argue that if it is not costly to determine which goods are high quality goods and argue that if it is not costly to determine which goods are high quality goods and which goods are lower quality goods then the pricing mechanism will simply adjust prices to reflect any quality differences. However, if getting the information about the quality of the good is costly then it is no longer plausible to believe that both the buyer and the seller have the same information about the good involved in the transaction. There are most certainly many markets in the “real world” in which it may be very costly or even impossible to get accurate information about the quality of the goods being sold. One example is the labour market. In any model that we have discussed so far, labour was a homogeneous product meaning that everyone had the same “kind” of labour and supplied the same amount of effort per hour worked. This is clearly not the case in the “real world”. For practical purposes, it may be very difficult for firms to determine how productive its employees are (or will be once hired).
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Costly information is not just an issue for labour markets. Similar issues arise in markets for consumer products. When a consumer buys a used car it is often very difficult for them to ascertain whether or not the car is a good car or a “lemon”. On the other hand, the seller of the used car likely has a pretty good idea about the quality of the car. We will see that this asymmetric information is apt to cause a substantial problem with the efficient operation of a market. THE MARKET FOR LEMONS Let’s consider a model of a market where the buyers and sellers have different information about the quality of the goods being sold (see Akerlof) [1] . Consider a market with 100 people that want to sell their used cars and 100 people that want to buy a used car. Suppose that everyone knows that 50 of these cars are “plums” (i.e. good cars) and 50 of these cars are “lemons” (i.e. bad cars). The current owner (seller) of the car knows the quality but the prospective buyers don’t know whether any given car is a plum or a lemon. Further, the owner of a lemon will be willing to part with it at a price of $1000 and the owner of a plum will be willing to part with it at a price of $2000. The buyers will be willing to pay $1200 for a lemon and $2400 for a plum.
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This note was uploaded on 03/28/2010 for the course ECON 301 taught by Professor Coreyvandewaal during the Winter '09 term at Waterloo.

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Lecture19 - Lecture!#19 INFORMATION ECONOMICS INFORMATION...

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