MIT14_03F10_lec17

MIT14_03F10_lec17 - Lecture Note 17: Private Information,...

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Unformatted text preview: Lecture Note 17: Private Information, Adverse Selection and Market Failure 14.03/14.003, Microeconomic Theory and Public Policy, Fall 2010 David Autor, Massachusetts Institute of Technology December 1, 2010 1 Private Information, Adverse Selection and Market Failure Where there is private information, there is an incentive for agents to engage in strategic behavior. For example, if you are selling a product, and your buyer knows the distribution of product quality but not the quality of the individual product that you posses, how much should the buyer be willing to pay? The intuitive answer might be the expected value of the product, or perhaps the certainty equivalent of this lottery. But this answer ignores the an important consideration: The choice of what product you sell may depend on what price the buyer oers. And the price that the buyer oers may depend on what product she thinks you ll sell at that price. The equilibrium outcome in which buyer and seller expectations are aligned that is, the buyer gets what she wants at the price she oers may be far from e cient. 1.1 A bit of background Economists had historically conjectured that markets for information were well-behaved, just like markets for other goods and services. One could optimally decide how much information to buy, and hence equate the marginal returns to information purchases with the marginal returns to all other goods. In the 1970s, economists were brought to reevaluate this belief by a series of seminal papers by Akerlof, Rothschild-Stiglitz, and Spence. These economists all went on to share the 2001 Nobel for their work on the economics of information. We will discuss 1 all three contributions. (The coauthor on the Stiglitz paper, Michael Rothschild, did not receive the Nobel.) Information is not a standard market good: Non-rivalrous (no marginal cost to each person knowing it) Extremely durable (not consumed) Not a typical experience good where you can try before you buy. Cannot readily allow you to sampleinformation without actually giving you information. Unlike other goods (or their attributes), information is extremely di cult to measure, observe, verify. This combination of odd properties often gives rise to settings where information is at least potentially asymmetric . That is, some agents in a market are better informed than others about the attributes of a product or transaction. The most natural (and surely ubiquitous) way in which this occurs is that buyers may have general information about the averagecharacteristics of a product that they wish to purchase whereas sellers will have specifc information about the individual product that they are selling....
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MIT14_03F10_lec17 - Lecture Note 17: Private Information,...

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