I i it must either give up allocative e ciency or

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Unformatted text preview: e¢ ciency trade-o¤ The three previous …gures illustrate the fact that the …rm cannot achieve its ideal solution. I I It must either give up allocative e¢ ciency or give away some rents to the consumer. This is the so-called rent-extraction/e¢ ciency trade-o¤ . Claim: When making the optimal trade-o¤, the …rm will never choose to give up only rent-extraction. I This is an important result, as it means that the informational asymmetry leads to Pareto ine¢ ciency. Why will the …rm choose to give up allocative e¢ ciency? I Next slide! J. Lagerlöf (U of Copenhagen) Microeconomics (MikØk) 3: L2-II Spring ‘ 11 7 / 29 Fully Non-Linear Tari¤: Graphical analysis (4/5) Why give up some allocative e¢ ciency? If not doing that, the …rm would have to reduce the high type’ s price with the amount ∆t indicated in the …gure ([L2-II, …g. 4]). In that situation it will always payo¤ to choose a q at least s slightly below qFB , somewhere along the low type’ indi¤. curve. I I This will save on the amount with which the high type’ price s must be reduced. But it comes at zero cost (at least the …rst tiny step). Why zero cost? This is because the pro…t the …rm makes on the low type, given that the low type is on its indi¤erence curve, is maximized at qFB . I Hence a small move away from q FB will lead to a loss of “second-order” magnitude only (the gradient of the pro…t function is zero at q FB — see …gure [L2-II, …g. 5). J. Lagerlöf (U of Copenhagen) Microeconomics (MikØk) 3: L2-II Spring ‘ 11 8 / 29 Fully Non-Linear Tari¤: Graphical analysis (5/5) Conclusions from this graphical analysis The …rm’ ideal solution is not achievable when there is s asymmetric information. I The...
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