Week 13 Lecture_Signaling and Moral Hazard (1)

Week 13 Lecture_Signaling and Moral Hazard (1) - Week 13...

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Week 13 Signaling, Screening and Moral Hazard
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Signaling Adverse selection is an outcome of an informational deficiency. What if information can be improved by high-quality sellers signaling credibly that they are high-quality? E.g. warranties, professional credentials, references from previous clients etc.
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Signaling A labor market has two types of workers; high-ability and low-ability. A high-ability worker’s productivity is a H . A low-ability worker’s productivity is a L . 0 < a L < a H .
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Signaling A fraction h of all workers are high-ability. 1 - h is the fraction of low-ability workers. Outside options are O H = O L = 0
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Signaling Each worker is paid his expected productivity. If firms knew each worker’s type they would pay each high-ability worker w H = a H pay each low-ability worker w L = a L .
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Signaling If firms cannot tell workers’ types then every worker is paid the (pooling) wage rate; i.e. the expected productivity w P = E(a) = (1 - h ) a L + ha H .
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Signaling w P = (1 - h ) a L + ha H < a H So high-ability workers have an incentive to find a credible signal.
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Signaling Workers can acquire “education”. Education costs a high-ability worker c H per unit and costs a low-ability worker c L per unit. c L > c H .
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Signaling Suppose that education has no effect on workers’ productivities; i.e., the cost of education is a deadweight loss.
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Separating Equilibrium Is there a separating equilibrium? Low type and high type do something different and none has incentive to mimic the other?
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Separating Equilibrium Q: Given that high type chooses e H > 0 units of education, if low type is okay with being recognized as low type, what level of education he will choose? A: Zero. Low-ability workers will be paid w L = a L when they are recognized to be low type.
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Separating Equilibrium High-ability worker does not want to mimic low-ability worker: (i) w H - w L = a H - a L c H e H c H 0, And low ability worker does not want to mimic high type. (ii) w H - w L = a H - a L c L e H c L 0. (i) and (ii) can both be satisfied because of the assumption that c L > c H.
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Separating Equilibrium H H L H e c a a - H L L H e c a a - and together require . H
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Week 13 Lecture_Signaling and Moral Hazard (1) - Week 13...

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