104 Flashcards
how people’s taste for risk
affects their choice among options (investments, career
choices, consumption bundles) with uncertain outcomes.
Expected Utility Theory
The amount that a risk-averse person would pay to avoid taking a risk. For example, an individual may buy insurance to avoid risk.
Risk Premium
In a perfectly competitive market there are…
no transaction costs
Name some of the reasons for market failure
- Asymmetric Information
- Externalities
- Economies of Scale
can be broadly defined as the costs that arise
from the implementation and usage of institutions.
Transaction Costs
Deviation from economic rationality. Definition by Herbert A. Simon (1957):
“ agents experience limits in formulating and solving complex problems and in processing (receiving, storing, retrieving, transmitting) information
Bounded Rationality
Contracts cannot specify the behavior for every possible situation, thus they are…
Incomplete Contracts, which result in follow-up problems.
hold-up problem is central to the theory of incomplete contracts and shows the difficulty in writing complete contracts.
Reasons for incomplete contracts:
- Ex-post surprises
- Very high negotiation costs
- Very high enforcement costs
- Loopholes
Value of transaction-specific investment minus value of the second-best transaction-specific investment
Quasi-rent
Vertical intregration vs Horizotal.
Vertical integration would be buying the seller of parts, horizontal would be buying another similar company to what you do(comcast buying time warner)
Situation in which one party to a transaction has relevant
information that another party does not have
asymmetric information
Two types of asymmetric information:
Hidden action(endogenous) - Agent can take unobserved actions. 2. Hidden information (exogenous) - Agent has information on important characteristics or states of nature, which the principal does not have.
Problem arising when agents (e.g., seller of a product or firm’s managers) pursue their own goals rather than the goals of principals (e.g., the buyer of the product or the firm’s owners).
principal–agent problem
Opportunism characterized by an informed person’s taking advantage of a less-informed person through an unobserved action.
moral hazard
Form of market failure resulting when different qualities are sold at a single price
because of asymmetric information.
adverse selection
incentive compatibility constraint
A’s expected net income resulting from eH must be at least as high as the expected net income resulting from eL.
A return received in an activity that is in excess of the minimum needed to attract the resources to that activity.
Rent
Process by which sellers send signals to buyers conveying
information about product quality.
market signaling
-Example: Job Market
Action by either a producer or a consumer which affects other producers or consumers, but is not accounted for in the market price.
externality
Principle that when parties can bargain without (transaction) costs and to their mutual
advantage, the resulting outcome will be efficient regardless of how property rights are
specified. Ex-post we can always reach Pareto-efficient allocations.
Coase theorem
Game theory example in which two parties must make a decision; if they both work together and choose the best desision that they profit the most, but if one doesn’t, he suffers so they both choose the worst option.
prisoners’ dilemma
dominant strategy
Strategy that is optimal no matter what an opponent does.
Set of strategies or actions in which each player does
the best it can given its competitors’ actions.
Nash equilibrium
Vertical Problems vs Horizontal Problems:
Vertical is between corporative actors at different hierarchy levels, Horizontal is at the same hierarchy level
Explanation for the presence of unemployment and wage discrimination which recognizes that labor productivity may be affected by the wage rate.
efficiency wage theory
Principle that workers still have an incentive to shirk if a firm pays them a market-clearing wage, because fired workers can be hired somewhere else for the same wage.
shirking theory
Wage that a firm will pay to an employee as an incentive not to shirk. It is above the market-clearing wage.
efficiency wage
Explains why wage differences are not based on marginal productivity, but instead upon relative differences between the individuals. Higher wages function as tournament prices. Exact output/productivity does not need to be measured, only the relative ranking between individuals is necessary
Rank-order tournaments
Activities of employees to influence supervisors’ assessment of performance and abilities to their own advantage.
nfluence activities
The tendency for central controllers to base next year’s targets on last year’s performance. Thus, managers who expect still to be in place in the next target period have a perverse incentive not to exceed targets even if they could easily do
ratchet effect
Horizontal Problems in Organizations:
Horizontal Problems, Natural dependencies(division of labor), Artificial dependencies(generated by incentives ex:sabotage, rat race)
The setting of the price for goods and services sold
between legal entities within an enterprise.
transfer pricing
a state of allocation of resources in which it is impossible to make any one individual better off without making at least one individual worse off.
Pareto efficiency
the amount of wealth, that if held with certainty, would
yield the same utility as an uncertain prospect.
Certainty Equivalent
Name the risk averse levels of Arrow-Pratt Measure:
p>0 Risk Averse, P
An organization with a functional structure
groups employees according to similar
sets of roles and tasks.
. An organization with a divisional structure
groups employees around products,
locations, or markets.
What helps to minimize influence activities?
Reduced Wage Differentials
To reduce risks, a firm should invest in
projects where the outcomes are negatively
correlated.
What are solutions to overcome problems arising from the internal allocation of goods?
Auctions
Groves/Loeb Mechanism
Profit Sharing
If two firms cannot agree on things like location, what type of game theory problem is this?
Coordination Problem,
A firm with two departments (A and B) produces a quantity q of a final product and sells it for the price p on the market. Department A produces a semi-finished product, while department B finishes the product and sells it on the market. What determines the efficient production level?
p = MCA + MCB
There are the two lotteries L1 and L2. Lottery L1 yields $10 with certainity, while lottery L2 yields $6 with probability 1/3 and $15 with probability 2/3. What are the expected values of the two lotteries?
E[L1] = 10, E[L2] = 12
