11 - asymmetric information Flashcards
why does AI matter?
An agent with a better information has comparative advantage to other parties and can use this information to modify his actions or choices in his favor. AI leads to market failure.
what do we mean when we say that AI can lead to market failure?
AI can have bad consequences for economic efficiency: some trades that would create surplus do not take place
what happens when there is perfect information for everyone involved in the transaction?
allocation is efficient because both seller and buyer can distinguish the type of cars that are sold for C<p></p>
what happens when there is total ignorance for everyone involved in the transaction?
no one knows the quality of the cars: calculate EV of buyer and seller. all cars are traded EVC<p></p>
what happens when asymmetric info for sellers in the transaction?
sellers know the quality, but EV of buyer is lower than C of GC: therefore, seller of GC exit the market (adverse selection) and buyers will realize that only cars on the market are lemons. therefore, in equilibrium, only lemons are sold at a price of C<p></p>
what is a solution to adverse selection?
signalling (inspection for a car)
how can a signal be credible in the example of an inspection?
Credible signal: something that only ppl with a good product (car) would do because its too costly for someone with a lemon to do
It would be credible to buyers if it is more costly for the owner of a lemon to pass the inspection (taking into account of the cost of making reparations) than for the owner of a GC
in the case of signalling with insurance for GC and L, what happens?
Lemons choose not to get an inspection, while owners of good cars take and pass inspection. in equilibrium, all cars are sold and efficiency in the market is recovered. however, there is a cost since GC get inspected for a certain price. the cost for achieving efficiency is the nb of cars x the price of inspection
what is the difference between signalling and screening?
- signalling come from the initiative of the informed party (a seller)
- screening comes from the initiative of the uninformed party (an insurer)
how can high quality indviduals solve adverse selection?
One way to solve adverse selection is for high quality individuals to signal to the market this high quality by using a costly instrument that would not be used by low quality individuals (advertisement, education, expensive stuff, large investment, for example are all ways to convince other ppl of something)
what is a direct way to solve AI?
Certification: direct way to solve the info asymmetry. If credible it transmits the info directly to the uninformed party and thus makes asymmetry disappear. 2 issues are the credibility of the agency that certifies the quality of the product and the cost of certification
what is reputation?
Reputation: establish reputation for quality which comes through dvlpmt of a brand that consumers recognize and trust (willing to pay more because they know the product is good quality). Firms thus have no incentive to produce goods of bad quality because it would lead to loss of reputation = loss of appeal and value
