37. Asymmetric Information - Solutions

# 37. Asymmetric Information - Solutions - Chapter 37 NAME...

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Chapter 37 NAME Asymmetric Information Introduction. The economics of information and incentives is a rela- tively new branch of microeconomics, in which much intriguing work is going on. This chapter shows you a sample of these problems and the way that economists think about them. 37.1 (0) There are two types of electric pencil-sharpener producers. “High-quality” manufacturers produce very good sharpeners that con- sumers value at \$14. “Low-quality” manufacturers produce less good ones that are valued at \$8. At the time of purchase, customers cannot distin- guish between a high-quality product and a low-quality product; nor can they identify the manufacturer. However, they can determine the quality of the product after purchase. The consumers are risk neutral; if they have probability q of getting a high-quality product and 1 q of getting a low-quality product, then they value this prospect at 14 q +8(1 q ). Each type of manufacturer can manufacture the product at a constant unit cost of \$11.50. All manufacturers behave competitively. (a) Suppose that the sale of low-quality electric pencil-sharpeners is ille- gal, so that the only items allowed to appear on the market are of high quality. What will be the equilibrium price? \$11.50. (b) Suppose that there were no high-quality sellers. How many low-quality sharpeners would you expect to be sold in equilibrium? Sellers won’t sell for less than \$11.50, consumers won’t pay that much for low-quality product. So in equilibrium there would be no sales. (c) Could there be an equilibrium in which equal (positive) quantities of the two types of pencil sharpeners appear in the market? No. Average willingness to pay would be \$11, which is less than the cost of production. So there would be zero trade.

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454 ASYMMETRIC INFORMATION (Ch. 37) (d) Now we change our assumptions about the technology. Suppose that each producer can choose to manufacture either a high-quality or a low-quality pencil-sharpener, with a unit cost of \$11.50 for the for- mer and \$11 for the latter, what would we expect to happen in equilib- rium? No trade. Producers would produce the low-quality product since it has a lower production cost. If all producers produce low-quality output, costs will be \$11 and the willingness-to-pay for low quality is \$8. (e) Assuming that each producer is able to make the production choice described in the last question, what good would it do if the government banned production of low-quality electric pencil-sharpeners? If there is no ban, there will be no output and no consumers’ surplus. If low-quality products are banned, then in equilibrium there is output and positive consumers’ surplus. 37.2 (0) In West Bend, Indiana, there are exactly two kinds of workers.
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37. Asymmetric Information - Solutions - Chapter 37 NAME...

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