12 - Information Flashcards
Mean or Expected Value
Sum of the resulting probabilities times the resulting payoffs.
Does not communicate degree of risk.
Variance
Quantifies the degree of risk associated with random outcomes.
The variance of a random variable is the sum of the probabilities that different outcomes will occur times the squared deviations from the mean of the random variable.
Standard Deviation
The square root of the variance.
The outcomes for any random variable will fall within 2 standard deviations from the mean at least 75% of the time.
St. Petersburg Paradox
The diminishing marginal utility of income.
The difference between the expected value and the amount an individual is willing to pay.
The measure of risk has more to do with a person’s assessment of perceived value. Satisfied people do not want as much and are more risk averse. Winning first million is far more satisfying than winning the 100th million.
Risk Aversion
Ceteris Paribus a customer will choose the more familiar option.
Product quality uncertainty increases aversion
Send free samples
Comparative benefits advertising
Chain stores lower aversion because there is a predictable experience compared to local diner
Insurance in the form of money back guarantees and extended warranty plans reduce uncertainties.
Cost of Search vs Reservation Price
The reservation price is that which the customer is indifferent to buying or searching.
Where search cost crosses the expected benefit curve equates to the reservation price.
EB(R) = c
P > reservation means reject
P< reservation means accept
As search costs increase, more higher prices are acceptable.
Asymmetric Information
When some market participants have more information. Those with less information routinely choose not to participate in transactions.
Adverse Selection
The unintended outcome of attracting undesirable inputs with hidden characteristics.
Offering more sick time attracts the unhealthy.
Charging higher premiums attracts poor drivers. Better for firm to charge low premiums and reject all with poor records - poor drivers and unlucky good drives.
Moral Hazard
When one party insulates another party from economic loss but the protected party takes hidden action to harm its protector.
Principal-Agent Problem. On strait salary the manager is insulated by the contract and shirking is likely.
Deductibles are how insurers reduce moral hazard. The insured have some skin in the game.
Signaling
Must be observable and difficult to mimic.
The unworthy are generally unwilling to expend the cost of effort to mimic the signal - like earning an MBA.
Screening
Methods uniformed parties use to sort inputs according to characteristics.
With people, providing options allows them to self-select without Manager knowing their hidden characteristics.
English Auction
Ascending bidding
Sequential bidding
Known competitive bids
Winner pays highest full amount bid that exceeds second highest bid. The winner does not necessarily pay their full value estimate of the item.
Key difference is knowledge
First Price -
Sealed-bid Auction
Simultaneous bidding
Unknown competitive bids
Winner pays highest full amount bid which is their full value estimate.
With respect to knowledge and amount paid, the Dutch Auction and First-Price Sealed-Bid Auction are strategically identical.
Second Price -
Sealed-bid Auction
Simultaneous bidding
Unknown competitive bids
Highest bidder wins but pays second highest bid amount which is less than their value estimate of the item.
Key difference is amount paid by winner.
Dutch Auction
Descending values
Unknown competitive bids
First bid wins and pays
Only one bid per auction
With respect to knowledge and amount paid, the Dutch Auction and First-Price Sealed-Bid Auction are strategically identical.
Independent Private Values
The value placed on an item based on personal taste is known only to that bidder. This is a form of asymmetric information.
English - remain active till price exceeds your value estimate
Second-Price Sealed-Bid - bid only full value estimate for the item
First-Price Sealed-Bid and Dutch - bid less than full value estimate based on number of bidders and range of possible but unknown valuations.
b = v - [(v-L)/n]
Correlated (Affiliated) Value Estimates
When the item’s value is influenced by relative interest level among bidders. All bidders assume other bidders have access to information on value. A particular bidder’s value estimate will likely be higher if they know other bidders highly value the item.
English - remain active till price exceeds personal value estimate but adjust estimate based on information gained through action process.
Common-Value Auction
A situation where the underlying value is the same for all bidders and individual taste has no impact. Uncertainty is in how bidders interpret available information.
Avoid Winner’s - Curse
Winner’s Curse
In Common-Values auctions -
The winner can assume their value estimate was inaccurate and they overpaid.
To avoid, personal value estimates should be revised downward. This is called shrinking bids.
For risk-neutral bidders:
Expected revenue when bidders are limited to independent private value estimates
Expected revenue when value estimates are affiliated.
Risk-neutral bidders are willing to bid lower and risk losing to gain higher profit if they win!
Independent Values - All auction types generate the same revenue level because all bidders are uninfluenced by information pooling.
Affiliated values
English > Second-Price > First-Price = Dutch
Bidders shrink less in English and Second.
NOTE : I believe a winner pays more in English auction based on independent values because of bid increment.
For risk-averse bidders:
Expected revenue when bidders are limited to independent private value estimates
Expected revenue when value estimates are affiliated.
Ironically, the risk-averse will bid higher in some situations because they do not want to risk losing.
When value estimates are independent:
First = Dutch > Second = English
When value estimates are affiliated:
More information bolsters English bidding.
English > Second >< First = Dutch
