ECON 111 Notes - Adverse Selection

ECON 111 Notes - Adverse Selection - Econ 111 Notes Moral...

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

Econ 111 Notes – Moral Hazard I. Adverse Selection a. Characteristics a.i. Asymmetric Information a.i.1. Where the buyer or seller knows characteristics about the product that the other doesn’t know a.i.2. Ex: A used car. “The market for lemons.” a.i.2.a. Lemons = Used Cars that break down a.i.2.b. Plums = Used Cars that are well taken care of a.i.2.c. The Expected Value = (Value of good outcome)(Probability of Good Outcome) + (Value of Bad Outcome)(Probability of Bad Outcome) a.i.2.c.i. $2000 + $1000 = $3000 a.i.2.c.ii. $800 + $1600 = $2400 (Chances of getting a plum – 4/20 = 20%) a.i.2.c.iii. $400 + $1,800 = $2200 (Chances of getting a plum – 1/10 = 10%) b. The Problem b.i. Adverse Selection b.i.1. The only products in the market are “lemons” and that the market is only made up of poor quality selection c. Solutions c.i. Private Institutions that provide information c.ii. Public Institutions that provide information also c.iii. Lemon Laws c.iii.1. Required Disclosure c.iv. Guarantees & Warranties c.iv.1. Guarantees = Get your money back
Image of page 1

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

Image of page 2
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: c.iv.2. Warranties = Repair/replace your product c.v. Screening c.v.1. When the uninformed side requires the informed side to perform an act or take a test Signaling When the informed side doesn’t act or achieve a goal in order to send the signal to provide information to the uninformed side James -> 4 x $50,000 = $200,000 Jimbo -> 4 x $60,000 = $240,000 Benefit of USF Degree = $220,000 James would go because costs are less than the benefits but Jimbo would not go to USF because the costs are more than the benefits II. Moral Hazard a. Characteristics a.i. Situations that encourage bad behavior b. Problem b.i. Bad behavior, excessively risky and harmful to society b.ii. Ex: If you are driving and not wearing a seat belt or has an air bag, it encourages more reckless driving because you feel safer c. Solution c.i. Change the situation so that there is no incentive to behave badly...
View Full Document

  • Fall '11
  • MarioB.Muzzi
  • Microeconomics, Market failure, Information asymmetry, Adverse selection, I. Adverse Selection

{[ 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