Lecture12 - 13 - agency moral hazard adverse selection


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Unformatted text preview: quality than the others Suppose there is some signal that is less costly to provide for sellers of good cars than for sellers of bad cars. The seller of a high quality car may be willing to offer a guarantee because the car is unlikely to break down. On the contrary, the seller of a bad car will not offer a guarantee because the car is very likely to break down, in which case the seller will have to pay the damages. Thus, the cost of offering a guarantee is lower for a seller of a high quality car than for a seller of a low quality car. Sellers of high quality cars can choose to offer a guarantee, while sellers of low quality cars will never offer a guarantee. 25 Signaling If the market (buyers) understands that only good cars will be guaranteed but that bad cars will not, then if a particular car is guaranteed by the seller the market can be sure that the car is good. if a guarantee is not offered, then the market can be sure that the car is bad. Thus, the market can accurately price each type of car separately. Both types of cars will be bought and sold, with transactions occurring at different prices. This is a major improvement on the previous case, where good cars were not sold in the market. 26 Forma...
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This document was uploaded on 03/09/2014 for the course COMM 371 at UBC.

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