CHAPTER 17 - PHALL-82241 PINDYCK CHAPTER 17 page 6 of 10...

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Unformatted text preview: PHALL-82241 PINDYCK CHAPTER 17 page 6 of 10 FIGURE 17.1 The Market for Used Cars PH PL SH $10,000 $10,000 SL DH $7500 $7500 DM DM $5000 DLM DLM $5000 DL DL 25,000 50,000 (a) High-Quality Cars 50,000 75,000 (b) Low-Quality Cars When sellers of products have better information about product quality than buyers, a “lemons problem” may arise in which low-quality goods drive out high quality goods. In (a) the demand curve for high-quality cars is DH. However, as buyers lower their expectations about the average quality of cars on the market, their perceived demand shifts to DM. Likewise, in (b) the perceived demand curve for low-quality cars shifts from DL to DM. As a result, the quantity of high-quality cars sold falls from 50,000 to 25,000, and the quantity of low-quality cars sold increases from 50,000 to 75,000. Eventually, only low quality cars are sold. Fig 17-01.eps PHALL-82241 PINDYCK CHAPTER 17 page 7 of 10 FIGURE 17.2 Signaling (a) Group I Value of college education (b) Group II Value of college education $200,000 $200,000 C I ( y) = $40,000 y $100,000 $100,000 C II ( y) = $20,000 y B( y) B( y) 0 1 2 Optimal choice of y for group I 3 4 5 6 y* Years of college 0 1 2 3 Optimal choice of y for group II 4 5 y* Years of college Education can be a useful signal of the high productivity of a group of workers if education is easier to obtain for this group than for a low-productivity group. In (a), the low-productivity group will choose an education level of y = 0 because the cost of education is greater than the increased earnings resulting from education. However, in (b), the high-productivity group will choose an education level of y* = 4 because the gain in earnings is greater than the cost. Fig 17-02.eps 6 PHALL-82241 PINDYCK CHAPTER 17 page 8 of 10 FIGURE 17.3 The Effects of Moral Hazard Cost per mile $2.00 $1.50 MC $1.00 MC� $0.50 0 D = MB 50 100 140 Miles per week Moral hazard alters the ability of markets to allocate resources efficiently. D gives the demand for automobile driving. With no moral hazard, the marginal cost of transportation MC is $1.50 per mile; the driver drives 100 miles, which is the efficient amount. With moral hazard, the driver perceives the cost per mile to be MC = $1.00 and drives 140 miles. Fig 17-03.eps PHALL-82241 PINDYCK CHAPTER 17 page 9 of 10 FIGURE 17.4 Incentive Design in an Integrated Firm Bonus (dollars per year) Q f = 30,000 10,000 Q f = 20,000 Q f = 10,000 8000 6000 4000 2000 0 10,000 20,000 30,000 40,000 Output (units per year) A bonus scheme can be designed that gives a manager the incentive to estimate accurately the size of the plant. If the manager reports a feasible capacity of 20,000 units per year, equal to the actual capacity, then the bonus will be maximized (at $6000). Fig 17-04.eps PHALL-82241 PINDYCK CHAPTER 17 page 10 of 10 FIGURE 17.5 Unemployment in a Shirking Model Wage SL No-Shirking Constraint (NSC) Demand for Labor we w* DL Le L* Quantity of labor Unemployment can arise in otherwise competitive labor markets when employers cannot accurately monitor workers. Here, the “no shirking constraint” (NSC) gives the wage necessary to keep workers from shirking. The firm hires Le workers (at a higher than competitive efficiency wage we), creating L* ? Le of unemployment. Fig 17-05.eps ...
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This note was uploaded on 09/28/2011 for the course ECON 105 taught by Professor during the Spring '11 term at Indian School of Business.

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