Week 11 Lecture_Asymmetric Information

Week 11 Lecture_Asymmetric Information - Week 11 Asymmetric...

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Week 11 Asymmetric Information Screening, Moral Hazard
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Signaling and Screening Signaling: The informed party takes action that can reveal information about their types. Screening: the uninformed party design a mechanism to induce the different types of the informed party to take different actions.
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Screening Worker’s ability is unobserved. The firm can offer two pairs: 1. (Difficult task, a higher wage) 2. (Easy task, a lower wage) Let a worker to choose Since it is more painful for a low- type to do the difficult task than a high type, there are separating equilibria.
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Asymmetric information Adverse selection: Hidden information At the time of contracting Moral Hazard: Hidden action After signing of a contract
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Moral Hazard If you have full car insurance are you more likely to leave your car unlocked? Moral hazard is a consequence of asymmetric information: as insurance company cannot perfectly monitor your actions.
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Moral Hazard Anticipating that you will be less careful if you buy insurance, what can the insurance company do? “Deductible”
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Moral Hazard A big bank knows that if it fails the government will be so scared of the impact on the economy, it will bail the bank out. Do you think the bank will still be careful in who they lend the money to? Tight regulation?
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Moral Hazard A company hires a sales person Effort is not observable Output of the effort is observable How to contract with the worker so that the worker will not shirk?
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