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Unformatted text preview: Chapter 17: Markets with Asymmetric Information CHAPTER 17 MARKETS WITH ASYMMETRIC INFORMATION TEACHING NOTES This chapter explores different situations in which one party knows more than the other, or in other words, what happens when there is asymmetric information. Section 17.1 discusses the case where the seller has more information than the buyer, and section 17.2 discusses market signaling as a mechanism to deal with the problem of asymmetric information. Section 17.3 discusses the moral hazard problem where one party has more information about their behavior than does the other party. Section 17.4 discusses the principal agent problem and section 17.5 extends the analysis to the case of an integrated firm. Both sections address the issue of differing goals between owners and managers. Section 17.6 examines the efficiency wage theory. There are basically four topics that the instructor can pick and choose between depending on time constraints and general interest. It is best to introduce asymmetric information by reviewing the cases where microeconomics has assumed perfect information. For example, except for Chapter 5 and sections of Chapter 15, we have assumed perfect knowledge of the future (no uncertainty). In models of uncertainty, consumers and producers play games against nature. In models of asymmetric information, they are playing games with each other. Many of your students are likely to have bought or sold a used car and will, therefore, find the lemons model interesting. Start your presentation by asking the sellers of used cars how they determined their asking price. Emphasize the intuition of the model before presenting Figure 17.1. If they have understood the model, they should ask a high price to give the impression to buyers that the car they are selling is of high quality. Class discussion could consider whether the government should pass laws requiring warranties in the sale of used cars. The market for insurance is also one with which most students are familiar. Although car insurance is required in many states, liability limits may vary from policy to policy. Discuss how risk- averse individuals will want to purchase policies with higher limits and how insurance companies determine the riskiness of the insurance. If you have used the example of buying a house in Chapter 15, you may extend it here by considering how bankers determine whether borrowers will default on their home loans....
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This note was uploaded on 01/03/2011 for the course COMM 290 taught by Professor Brian during the Winter '09 term at The University of British Columbia.
- Winter '09