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Summary Complete exam material Moral Limits of Markets
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Complete summary of Moral Limits of Markets, lectures, necessary chapters (21, 22, 24), and the mandatory articles included.
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Chapter 24: Asymmetric informationAsymmetric information: when one party to an exchange has more or better information
than the other party.
→ principal-agent problem: how can a principal incentivize an agent to work in the
principal’s interest even when the agent has information that the principal does not?
Markets work best when traders know exactly what is being traded, then markets will attract
both buyers and sellers because each side expects trade to be mutually profitable. But when
one party to a (potential) trade has more information than the other party, the less informed
party may withdraw from the market and decide that trade is too risky or not in his or her
interest. In extreme cases, asymmetric information can mean that markets fail to exist.
Moral hazard: when an agent tries to exploit an information advantage in a dishonest or
undesirable way. → free rider: consumes but does not pay.
Two solutions to moral hazard and asymmetric information, are never without cost and they
are rarely perfect or complete:
1. Provide more information:
Ratings and reviews (can be fake), reputations (can be undeserved), contracts (rarely
fully align incentives), and signals (often noisy).
2. Reduce the incentive for the knowledgeable party to exploit their information advantage.
Adverse selection: occurs when an offer conveys negative information about the product
being offered.
Insurance company does not know who the bad risk or good risk is, therefore, it will state a
uniform fee. The good risks think the fee is too high and drop out, the insurance company is
left with the bad risks, the fee must increase, and again there is adverse selection.
Market features that help limit this adverse selection problem:
▪ Inspections or check-ups, to overcome asymmetric information.
▪ Group plans, to increase the chances of signing up both bad and good risks.
▪ Conscientiousness, some value insurance more than others, people who take the best
care of themselves are covered by health insurance.
Credible promise: one that the promisor has an incentive to keep.
Signal: expensive action that is taken to reveal information.
Lecture 1: Do markets shape our morals?
Separability thesis: material interest and moral sentiments have separate effects on
(market) behaviour. → they are additive, not interactive “the effects of each are independent
of the levels of the other”
Non separability theses: opposite, every business decision is also moral decision.
Markets cannot function if the principles and agents:
➔ Only take the outcome into account
➔ Only maximize a single value (e.g., utility)
Markets function optimally when balancing virtue, duties/norms and outcomes, and
maximization of justice, well-being, self-realization, happiness, etc.
,There are three frameworks for evaluating normative/moral aspects of business/economic
decisions (normative ethics):
1. Utilitarian ethics: consequentialist, judges decisions by their outcome. (Jeremy Bentham
and John Stuart Mill)
Example: attention economics is the idea that businesses used to compete for money
and now they compete for our attention, for example YouTube.
Hedonist utilitarianism: only pleasure and paint count; those choices are morally right
that give the greatest level of pleasure over pain.
Pluralist utilitarianism: many values count; pleasure, pain, beauty, and truth et.
2. Deontological ethics: study of duties and non-consequentialist, judges decisions by the
duties they obey. (Immanuel Kant)
the actions themselves are right or wrong, even if an action causes a better situation it is
not necessarily the right action.
Kant: the principles on which one acts should be capable of being willed as a universal
law. → killing innocent and lying is never right.
3. Virtue ethics: judges decisions by the moral character of the agent. (Aristotle, Confucius,
Elizabeth Anscombe)
If you are a virtuous person, your decision will be the right decision, because you have
learned who you are and what your place is in the world.
Virtue is the middle between two opposite extremes, according to Aristotle.
→ To be able to act morally right, one must cultivate one’s virtue.
Michael Sandel → Moral Machine market: Mercedes self-driving car
▪ Arguments for:
1. Libertarian: people are free to buy and sell if they do not violate others’ rights.
2. Utilitarian: market exchange benefit buyers and sellers, improving collective well-
being and social utility.
▪ Arguments against:
1. Fairness: price people pay = willingness + ability to pay.
2. Value corruption: employing a free market in some cases, corrupt essential values
(e.g., equal quality of security).
Policies Designed for Self-Interested Citizens May Undermine the ‘Moral
Sentiments’: Evidence from Economic Experiments – Bowles, S (2008)
Central question: can policies designed for self-interested citizens undermine moral
feelings?
Answer: Yes, the results show that economic incentives can be counterproductive when
they report that selfishness is an appropriate response. This will result in a learning
environment where people have more interesting motivation and thus diminish intrinsic
motivations. This will lead to greater disrespect and unjust intentions. These effect occur
because people act not only to acquire economic property but also to form dignified,
autonomous and moral persons.
Policies designed to attract the self-interest of people may be counter-intuitive if they signal
that selfishness is the appropriate response as people regard themselves as altruistic
behaviour.
Some economic incentives could diminish the ethical reasons for complying with social
norms (e.g., a fee for being late when picking up a child from day care diminishes the
incentive to pick them up on time to not inconvenience the day care centre).
, Often contracts cannot be complete, or fully enforced. There will be spill over effects, and
sometimes the cost only lies with the principal rather than the agent. Contracts should be
made so that each agent experiences the benefits and costs of their own actions.
However, sometimes incentives undermine ethical motives
Reasons for the failure of the separability assumption:
1. Framing: the way a decision situation is represented.
Incentives influence framing and may signal appropriate behaviour. These frame-shifting
effects of incentives may also occur in cases of where government regulations were
implemented to increase the common goal, however the result was a decrease in
common/ethical behaviour and an increase in selfish individual behaviour. People became
more self-interested because the way the see the decision situation is changed
counterproductive incentive.
2. Endogenous Preferences: when someone’s preference changed even after an
experience or incentive is removed.
Incentives change preferences because they affect key aspects of how we acquire our
motivations. This effect is hard to measure because it is a slow process that neds population-
level effects such as schooling.
3. Self-Determination:
When people derive pleasure from an action in the absence of other rewards, the
introduction of incentives may take away the sense of autonomy and pleasure from making
an ethical action. Incentives change preferences because they affect key aspects of how we
acquire our motivations. These effects include the fact that incentives influence both the
range of alternative preferences to which one is exposed and the economic rewards and
social status of those with preferences different from one's own.
4. Incentives convey information:
Principals select incentive based on their beliefs and how well the agent will work under each
incentive. The incentive selected reveals information on the principal’s preferences, and his
beliefs concerning the agent (e.g. principal wants to profit off the agent, does not believe the
agent will work well without an incentive). Sometimes, not using incentives implies trust in the
agent and can lead to greater mutual benefits. Incentives that are not imposed by people
who directly benefit (not the principal, e.g. the government) does not lead to compromise
social preferences.
Morals and Markets – Falk, A. & Szech, N. (2013)
Market interaction may erode moral values.
Central question: to what extend does market interaction changes how human subjects
value harm and damage done to third parties?
Answer: to a large extend, the subjects were willing to do a lot more harm and damage to
third parties in a market setting compared to an individual setting.
Possible reasons why market interaction may erode moral values is that
1. Feelings of guilt are shared between the buyer and seller.
2. Market interaction reveals social norms: seeing others trading allows people to think it is
normal and justifiable.
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