By carefully observing a workers behaviour the

- By carefully observing a worker’s behaviour, the employer might be able to infer
something about his productivity
- How a good is sold may allow the consumer to infer something about the quality
of the good.
What are possible implications of asymmetric information?
Categories of asymmetric information models I
Adverse Selection: Information asymmetry, which occurs when the seller knows more
about the product than the buyer.
Adverse Selection
Nature begins the game by choosing A’s type. Unobserved by P. A and P then agree to a
contract  Information is incomplete.
Suppose there is a marker for good cars and bad cars
Good cars: greater supply function and higher equilibrium price. If you can ’ t observe the
quality of the cars due to incomplete information then the demand has to estimate the
quality of the cars based on what they think.
- The buyer’s best guess for a given car is that the car is of average quality;
accordingly, he/she will be willing to pay for it only the price of a car of known
average quality.
- The owner of a ‘cherrie’ (good car) will be unable to get a high enoug h price to
make selling that car is worthwhile.
- Owners of good cars will not place their cars on the used car market, causing
buyers to revise downward their expectations for any given car.
- This motivates the owners of moderately good cars not to sell, and so on.
 A market in which there is asymmetric information with respect to quality
shows that the bad drives out the good. Only bad cars will be sold.
Asymmetric information can lead to adverse selection and therefore to a market failure.
 To avoid adverse selection problems we can use signalling and screening.
Application B. Job market signalling and screening
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Signalling Games
In many instances it will be to the benefit of the informed party to reveal her type to the
uninformed opponents.
- Quality Signalling
- Educational signalling
- Entry deterrence
Categories of asymmetric Information Models II
Adverse Selection with Signalling
Nature begins the game by choosing A’s type, unobserved by P. To demonstrate his type,
A takes an action that P can observe, before the contract is signed.
 Informed party moves first  Information is incomplete
Signalling: a strategy the informed party can use to reveal its private information in
order to prevent effects of adverse selection.
Common components:
- Nature chooses a type for player 1 that player 2 does not know but ‘cares about’
(common values)
- Player 1 has a rich action set in the sense that there are at least as many actions
as there are types, and each action imposes a different ‘cost’ on each type .