Topic14_Asymmetric Info

Topic14_Asymmetric Info - Topic 14 14 Asymmetric...

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Topic 14 Asymmetric Information atna K Shrestha Ratna K. Shrestha
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Introduction requently a seller or producer knows more Frequently a seller or producer knows more about the quality of the product than the buyer does. y Managers know more about costs, competitive position and investment opportunities than firm owners. This situation when one party knows more than others is called Asymmetric Information. 2
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troduction Introduction he lack of complete information when The lack of complete information when purchasing a used car increases the risk of the purchase and lowers the value of the car. p Markets for insurance, financial credit and employment are also characterized by asymmetric information about product quality. Such asymmetric information leads to opportunistic behavior, and hence market failure: (a) adverse selection and (b ) moral 3 hazard .
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Problems Due to Asymmetric Information ith asymmetric information informed party With asymmetric information, informed party benefits at the expense of uninformed or less informed party. py (1) Adverse Selection : When consumers lack information on a product quality (say used cars) and hence offer an average price (average of good and bad), sellers of good quality will not sell their products. 4
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arket for Health Insurance Market for Health Insurance nhealthy individuals know more about their Unhealthy individuals know more about their health than the insurance company. ecause unhealthy people are more likely to Because unhealthy people are more likely to want insurance, proportion of unhealthy people in the pool of insured people rises. Price of insurance rises so healthy people with low risk drop out – proportion of unhealthy people rises increasing price even more— Adverse Selection Problem 5
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arket for Insurance Market for Insurance uto insurance ompanies cannot Auto insurance companies cannot distinguish who are high-risk drivers and who are low-risk drivers, they will base premium on the average risk. Some with low risk will find the premium too high and choose not to insure. This will raise the accident probability and premiums. Low risk drivers will thus be driven out of the market. 6
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Problems Due to Asymmetric formation Information ) oral Hazard When one party has more (2) Moral Hazard : When one party has more information, then that party may take advantage of the uninformed party through unobserved actions. Example, (a) a worker may shirk if not monitored by the manager. (b) when you have auto insurance, you may be more reckless while driving. (c) Once you have fire insurance, you many not 7 take care of fire hazard.
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The Market for Used Cars ssume Assume Two kinds of cars – high quality and low uality quality Buyers and sellers can distinguish etween the two kinds of cars between the two kinds of cars In this case, there will be two markets – one for high quality and one for low quality.
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Topic14_Asymmetric Info - Topic 14 14 Asymmetric...

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