6. Chapter 22

Question 1

What are the 3 topics at the disciplines frontier to show how economists are trying to expand their understanding of human behaviour and society?

Answer 1

1. Asymmetric information- imbalance in information in society affects choices made
2. Political economy
3. Behavioural economics- bringing Psychology into economic issues

Question 2

What is information asymmetry?

What is a hidden action and hidden characteristic example?

Answer 2

A difference in access to knowledge that is relevant to an interaction
“I know something you dont know” taunt
Car seller knows more about the car then the buyer- hidden characteristic
Worker knows more that’s his employer about how much effort he puts into his job- hidden action

Question 3

What is a moral hazard?
Agent?
Principal?

Answer 3

Moral hazard- tendency of a person who is imperfectly monitored to engage in dishonest or undesirable behaviour
Agent- person who is performing an act for another person, called principal
Principal- person for whom the other person, the agent, is performing some act
Principal monitors agents work

Question 4

What are the 3 ways employers can deal with the moral hazard problem?

Answer 4

1. Better monitoring- cameras to catch irresponsible behaviour
2. High wages- higher paying means more motive to work
3. Delayed payment- delaying compensation so if caught slacking can be fired with no pay

Question 5

What is adverse selection?

Answer 5

Tendency for the mix of unobserved attributes to become undesirable from the standpoint of an uninformed party
Seller knows more about the attributes of good being sold than the buyer
Example: used cars

Question 6

What is signalling?

Answer 6

An action taken by an informed party to reveal private information to an uninformed party
Ex: advertising they have high quality products
Students getting degrees to signal they are high quality workers

Signals must be costly for the person portraying it
It must be less costly or beneficial for the person with the higher quality product

Question 7

What is screening?

Answer 7

An action taken by an uninformed party to induce an informed party to reveal information
Buyer of used car asking if mechanic can check out car first

Question 8

What are the 3 facts that complicate governments involving in asymmetric information?

Answer 8

1. Private markets can sometimes deal with information asymmetries on its own (signalling and screening)
2. Government rarely has more information than the private parties
3. Government itself is an imperfect institution

Question 9

What is the condorcet paradox?

Answer 9

The failure of majority rule to produce transitive preferences for society

Ex: A beats B, B beats C, but then C beats A in 3 separate votes

Question 10

What is the broad and narrow lesson of the condorcet paradox?

Answer 10

The narrow lesson is that when there are more than 2 options, setting the order of which items are voted can have a powerful impact on the outcome of a democratic election
The broad lesson is that majority voting by itself does not tell us what outcome a society really wants

Question 11

What is borda count?

Answer 11

A voting system where voters rank their selections and last place gets one point, second last gets 2 points, third last gets 3 points and so on

Question 12

What are the 4 properties that must be satisfied for a perfect voting system?

Answer 12

1. Unanimity- If everyone prefers A over B, then A should beat B
2. Transitivity- If A Beats B, and B beats C then A should beat C
3. Independence of irrelevant alternatives- ranking of A and B should not depend on if there’s a C option
4. No dictators- no person always gets his or her way, regardless of everyone else’s preferences

No voting system can fulfill these mathematically

Question 13

What is arrows impossibility theorem?

Answer 13

A mathematical result showing that, under certain assumed conditions, there is no scheme for aggregating individual preferences into a valid set of social preferences

Question 14

What is the median voter theorem?

Answer 14

A mathematical result showing that if voters are choosing a point along a line and each voter wants the point closest to his most preferred point, then majority rule will pick the most preferred point of the median voter

The median voter is a voter exactly in the middle of the distribution and according to this rule the majority rule will produce the outcome most preferred by the median voter

Question 15

What are homo economicus?

Answer 15

Rational species that as firm managers, maximize profits and as consumers they maximize utility

However we are Homo sapiens, not maximizes but satisficers

Question 16

What are the 3 main systematic mistakes people make in decision making?

Answer 16

1. People are over confident- too sure of our own abilities
2. People give too much weight to a small number of vivid observations- car is rated amazing but your one friend says it sucks so you listen to friend
3. People are reluctant to change their minds- we interpret evidence to hold beliefs we already have

Question 17

What is left digit bias?

Answer 17

The reason prices are often 4.99 and not 5.00 cause we interpret the 4 being cheaper

Question 18

What is the ultimatum game?

Answer 18

Two players are told they can win 100 dollars, they flip a count for player A and B
Player A divides 100 between them and player B can accept or decline it and they walk away with nothing
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