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Economics of Markets and Organizations Week 6 Summary
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Economics of Markets and Organizations Week 6 Summary including readings
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Week 6:Preparation: Chap 13: Games with
asymmetric information
Adverse selection problem: when only low-quality goods are traded on the
market if sellers
are better informed than the potential buyers.
Results in the “lemons problem” because low-quality second-hand cars are
sometimes called “lemons”. Also called adverse selection problem as the
uniformed party tends to select the wrong kind of trading partner. ≠ with moral
hazard: the lack of information is about the characteristics of the inform party
not the performance of the other party.
Can be solved or attenuated thanks to government intervention.
Market solutions: Screening devices or Signaling devices.
Uninformed party screens while the informed party signals.
Screening: the uniformed party imposes some mechanism that separates good
trading partners from bad ones.
A restriction on the menu of contracts is that it must be incentive compatible:
both types of customers should prefer the option designed for them over the
other one.
Incentive compatibility implies that the menu the insurance company will offer is
probably inefficient.
“If only the high-risk individuals would admit to their having high accident
probabilities, all individuals would be made better-off without anyone being
worse-off.
In some settings, it is difficult if not impossible for the uninformed party to screen
their informed trading partner.
The informed party may have the possibility to send a credible signal to the
uninformed party.
Persuasive advertising is particularly relevant for what economists call
“experience good”: a good which the consumer only observes the quality after
consumption. In contrast, “search goods” are goods for which the quality is
observable before consumption. So for them, advertising is purely informative.
According to one empirical study, the advertising/sales ratio (advertising
expenditures as a fraction of total sales) for experience goods is 3 times higher
than for search goods.
In an auction, bidders can submit bids on an object.
Attractive for the seller because:
- Don’t have to “guess” what a good price is because bidders incorporate
their willingness to pay in their bid.
- Efficient because the bidder with the highest value wins.
- He benefits by getting a substantial share of the winner’s willingness-to-
pay.
- Can drives up the price the seller receives for the object.
Auctions ≈ Bertrand competition because winner-takes-all market mechanism.
Under the First Price sealed-bid auction, one bidding and the highest wins.
Bidders will bid half of their value.
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