summary of asymmetric information in microeconomics. First, the asymmetric information is explained with the lemons problem and examples and the mechanism that mitigates this problem. Then, it discusses adverse selection in insurance firms. Finally, the moral hazard is linked to the asymmetric info...
—> asymmetric information:
- The lemons problem with examples
- The mechanism that mitigates lemons problem
—> adverse selection :
- Mitigating adverse selection in insurance
—> moral hazard :
- graphical approach with marginal bene t and marginal costs
- Lessening moral hazard
- Asymmetric information in a principal-agent relationship + example
- Signaling: education example —> mathematical and graphical approach
fi
, --> asymmetric information: a situation where there is an imbalance of information
across participants in an economic transaction
--> complete information: all market participants know everything important for
making decisions
• The lemons problem and adverse selection
◦ Lemon problem: asymmetric information problem that occurs when a
seller knows more about the quality of the good he is selling than the
buyer
◦ Observable quality VS. Unobservable quality: customers know that half
of the cars are new and half are not --> 50% chance that the car is a plum
(high quality) and 50% that the car is a lemon (low quality)
• So their WTP = (Price lemon * 0.5 + Price plum * 0.5) -->
anything more will be worse off in expectation
• Buyers can't sell good cars (plum) at this price and customers
know that that means sellers can only sell lemons and customers
know that --> NO CARS WILL BE BOUGHT
◦ Adverse selection: a situation where there are stronger incentives for “bad”
types of a product to be involved in a transaction than “good” types of the
product
• This asymmetry leads to poor-quality goods being disproportionately put
up for sale
▪ The average quality of items that are offered for sale is lower than
the average quality of all such items, including those not for sale
• The average value of used cars to buyers was $5,000, but
the average value of those offered for sale was $0
◦ information asymmetry harms the less-informed participants and those who
have more information !!
◦ Examples of the lemons problem
• quality of workmanship
• used capital goods sales
• Workers
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