Lecture12 - 13 - agency moral hazard adverse selection


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Unformatted text preview: lization of Signaling Suppose that the cost of providing a guarantee is higher for owners of bad cars than for those of good cars: Cb > Cg = 0 Think of “C” as the expected reimbursement to the buyer if the car breaks down. Assuming that good cars never break down, Cg = 0 Also assume that Cb > VH – VL: the cost of providing a guarantee when the car is bad is large Suppose that the market’s perceived valuation of the car is that it is good if a guarantee is offered, and bad if it is not. The market’s valuation for a car would then be V = VH if a guarantee is offered V = VL if a guarantee is not offered 27 Formalization of Signaling Given the market valuation above, will sellers of bad cars “mimic” sellers of good cars and offer a guarantee? And will sellers of good cars “mimic” sellers of bad cards and do not offer a guarantee? Given the market valuation, sellers of bad cars do not offer a guarantee, and the market prices their car at V L. If they do offer a guarantee which costs Cb, and the market prices it at VH, the no­ mimicking condition is: VL > VH – Cb [sellers of bad will not mimic sellers of good] Given the market valuation, sellers of good cars offer a guarantee (at zero cost), an...
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This document was uploaded on 03/09/2014 for the course COMM 371 at The University of British Columbia.

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