9 - Asymmetric Information

Question 1

Where is the information asymmetry in a market with adverse selection and m sellers and n buyers (n>m)?

Answer 1

Seller is better informed about quality than buyer, each buyer buys at most one unit.

Question 2

How do buyers and sellers value quality in an asymmetric information market?

Answer 2

buyers: willingness to pay equals q (i.e. U (q, p) = q - p)
sellers: values quality with αq, α∈(0,1) (i.e. Utility at price p and quality q: p-αq)

Question 3

How can you calculate the market equilibrium in a market of good and bad quality goods with no information?

Answer 3

1) calculate the reservation price, based on the probabilities of each outcome:
- > probability(bad)RP(bad) + probability(good)RP(good)
2) calculate the willingness to pay (same):
- > probability(bad)WTP(bad) + probability(good)WTP(good)
3) equilibrium if WTP >= RP, at p* = WTP (if there are more buyers than sellers at least)

Question 4

How can you calculate individual supply in a market of good and bad quality goods?

Answer 4

/ good quality: 1, if p >= RP(+) // 0, otherwise
S(P)ind. = |
\ bad quality: 1, if p >= RP(-) // 0 otherwise

Question 5

How can you calculate aggregate supply in a market of good and bad quality goods?

Answer 5

/ total # goods, if p >= RP(+)
S(P) = | # bad goods, if RP(-) =< p < RP(+)
\ 0, otherwise