301lec26

301lec26 - ECON 301 Microeconomics Professor Sergei...

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Slide 1 ECON 301 Microeconomics Professor Sergei Severinov Lecture Notes 26
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Slide 2 Economics of Information In many business and economics situations, some parties privately possess relevant information about demand, value and quality of the goods, costs, risks, a firm’s earnings and prospects. Such information may not be known by the parties on the other side of the transaction. In these cases, we say that information is asymmetric.
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Slide 3 Economics of Information Parties with an informational advantage (businesses, employees) have an incentive to misrepresent it, manipulate it or act in such a way that other parties incur losses dealing with the first party (insider trading, shirking, cost padding). This may have a detrimental effect on business transactions, trade, investment and growth (similar to a negative effect of hold-up on investment). Hence, we have to design methods of dealing with these problems.
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Slide 4 Types of Private Information Adverse Selection : a party has private information about her inherent properties (type). - A seller knows more about the quality of his/her product than a buyer (real estate). - Buyers know more about their valuations for the good than sellers. - Drivers know more about their driving habits (whether they are risky or safe) than an insurance company. - Health and life insurance: individuals know more about their health than insurance companies.
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Slide 5 Adverse Selection: More Examples. - A firm’s costs are not observed by the competitors or the government. -A worker knows her/his ability and work ethics better than the employers. -Executives have exclusive knowledge of their firm’s finances and its overall situations.
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Slide 6 Moral Hazard: Another Type of Informational Problem Moral Hazard exists when a party can take actions that are unobservable or cannot be controlled by the other party and negatively or positively affects that other party. -An insured can take effort to preserve her/his property or be careless. This is not observed by the insurer. -An employee can work hard or shirk. Managers often do not observe an employee’s effort.
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Slide 7 Moral Hazard - Executives can take actions that do not serve the interests of the shareholders, but enhance the managers’ career prospects and power. Examples: acquisitions, empire building, perks,
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301lec26 - ECON 301 Microeconomics Professor Sergei...

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