ECON 111 Notes - Adverse Selection

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

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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
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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 c.vi. Signaling c.vi.1. When the informed side doesn’t act or achieve a goal in order to send the signal to provide information to the uninformed side c.vi.1.a. James -> 4 x $50,000 = $200,000 c.vi.1.b. Jimbo -> 4 x $60,000 = $240,000 c.vi.1.b.i. Benefit of USF Degree = $220,000 c.vi.1.c. 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...
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  • Fall '11
  • MarioB.Muzzi
  • Microeconomics, Market failure, Information asymmetry, Adverse selection, I. Adverse Selection

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