{[ promptMessage ]}

Bookmark it

{[ promptMessage ]}

PS 22 moral hazard

PS 22 moral hazard - Intermediate Microeconomics Winter...

Info icon This preview shows pages 1–2. Sign up to view the full content.

View Full Document Right Arrow Icon
Intermediate Microeconomics, Winter 2008 Problem Set No 22 We will discuss the problem set next week but it will not be collected. Reading: "Tourist Trap Model," pp 646-649. Q1. Adverse Selection and Buying Stocks. Reconsider the problem of buying stocks. Suppose the value of the stock can be either high, medium, or low. Each of the three values is equally likely (i.e., 1 3 ). Values and costs are as follows V alue v c High 100 90 Medium 90 80 Low 80 70 So this is the same setup as in the lecture, but with three possible values instead of two. Again, the buyer makes a price o/er p and the seller accepts if p ° c j . a) Calculate the expected utility of the buyer if he o/ers p = 90 ; p = 80 ; p = 70 . b) The three prices from before are the only candidates for optimal o/ers. Why? c) Which of the three prices is actually the optimal o/er? d) Challenging. Suppose, the stock can have 11 possible values. For each value, the buyer is willing to pay more than the opportunity cost of the seller: Value V 1 V 2 V 3 V 4 V 5 V 6 V 7 V 8 V 9 V 10 V 11 Buyer v 100 90 80 70 60 50 40 30 20 10 0 Seller c 90 80 70 60 50 40 30 20 10 0 0 The probability of each of these values is the same, i.e., prob [ V i ] = 1 11 . What is the optimal o/er of the buyer? To °nd the optimal price o/er, you will have to compare the expected payo/ from the candidate prices p 2 f 0 ; 10 ; 20 ; ::::; 90 g . (You will not really need to calculate the exact numbers. But to give you an idea, if the buyer o/ers p = 50 , all sellers with costs equal to or below 50 accept the o/er. The expected value of o/ering p = 50 is: 1 11 (60 ± 50) + 1 11 (50 ± 50) + 1 11 (40 ± 50) + :::: +
Image of page 1

Info icon This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
Image of page 2
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}

What students are saying

  • Left Quote Icon

    As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

    Student Picture

    Kiran Temple University Fox School of Business ‘17, Course Hero Intern

  • Left Quote Icon

    I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

    Student Picture

    Dana University of Pennsylvania ‘17, Course Hero Intern

  • Left Quote Icon

    The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

    Student Picture

    Jill Tulane University ‘16, Course Hero Intern