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be prominently displayed in the window of each restaurant. A picture of a grade card is found below: These grade cards gave the restaurant an A if it scored 90-100% on the inspection, B if it scored 80-89%, C if it scored 70-79%. Anything less results in a card that 4Reference: “Limit Pricing and Entry under Incomplete Information,” by P. Milgrom and J. Roberts, Econometrica, 50, 1982, 443-459.
Problem Set 4 Page 5
Problem Set 4 Page 6 Until July 1, 1997, the inspections by the DHS included both an objective and a subjective element. The subjective aspect was the inclusion of an “establishment status score”, intended to be the inspectors overall evaluation of the hygiene status of the restaurant. Since July 1, 1997, the subjective component of the assessment has been removed and inspections are now objective in nature. Beginning with a score of 100, pre-specified points are deducted for each violation. For example, a food temperature violation results in a 5 point deduction, evidence of roaches results in a 3 point deduction and a functioning but unclean toilet results in a 2 point deduction. A minor change in the inspection scoring was again made on March 18, 1998, to add a small number of additional potential violations. Figure 1 shows how the hygiene scores changed after introduction of the new assessments and the grade cards. For the rest of this question just concentrate on the 50thpercentile line. This shows the score of the middle restaurant in the sample. So if in September 1995, the 50thpercentile is at 75, then half the restaurants had scores below 75 and half had scores above 75. The 50thpercentile is also called the median. The graph represents results from 57% of all restaurants in LA, with selection into the sample occurring randomly. (c) Describe what happens over time to the median hygiene score. (d) Why do you think the first assessment change had the effect it did on scores? (e) What was the effect of the introduction of the grade cards on hygiene? (f) Did the introduction of the grade cards solve the asymmetric information problem you identified in part (a)? If so, explain how. If not, explain why not. Your answer should clearly describe the economic effect of the initial asymmetric information problem, the mechanism by which this effect arises and how the grade cards changed this mechanism (if at all) and how this lead to the final outcome. Be sure to discuss both the theory and the evidence. Question 4: 1982 16 K classic pen A friend at a West Coast business school wants to buy a present for his father’s birthday. In particular, she knows that he wanted to get hold of a particular pen for his collection. She know that he’s particularly keen to get hold of the “1982 16 K classic”. Even though the list price in collector’s manuals is only $300, Fran’s willing to pay $600 for the pen. My friend has been unable to find the pen at the local dealers and decided to try a new website, . At this site people post descriptions of the items that they would like to buy and how much they’re willing to pay for them. Fran is aware that