Asymmetric information Flashcards
How can we calculate probability with frequency if we don’t have history of the event?
The number of times that one particular outcome occurred (n) out of the total number of times an event occurred N
What is the expected value and how can we calculate it?
Expected value is the value of each possible outcome times the probability of that outcome summed over all n possible outcomes (weighted sum)
What is variance?
Variance measures the spread of the probability distribution or how much variation there is between the actual value and the expected value
What is the standard deviation?
The square root of the variance and is a more commonly reported measure of risk. (The higher the standard deviation, the higher the associated risk)
When does asymmetric information exist?
When one party to a transaction knows a material fact that the other does not
What is a hidden characteristic?
Attribute of a person or thing known to one party but not others
What is a hidden action?
An act by one party to a transaction known to one party but not to others
What are the two main types of opportunistic behaviour?
- Adverse selection
- Moral hazard
What is adverse selection?
Those with weaker information will engage in harmful market behaviour
What is an example of adverse selection?
The used-car lemon market
If consumers are unable to identify high-quality goods before purchase what will consumers do?
They will pay the same price for all goods (regardless of quality)
Why will the market end up with just lemons?
Unravelling under asymmetric information
What is unravelling under asymmetric information?
If there is a range of car types and the E(v) is lower than the top range, they leave and this continues until there is only lemons
How can information asymmetry be broken?
Signalling and screening
How does competition from the demand side effect the price?
It drives up the price
What is the equilibrium in the labour market?
Combination of wages for each firm and an acceptance decisions for each worker, such that no firm and no worker can make themselves better off by changing their decision
If firms cannot tell worker type, what type of wage to they pay?
The pooling wage rate (expected value of low ability + high ability
What does the pooling wage rate mean for high ability workers?
As it is below their expected wage rate, it incentivises finding a credible signal
What is a two-stage model here?
Stage 1: Firms announce the wage for high and low-education
Stage 2: each worker chooses education then accepts contracts in any
Who is the cost of education higher for?
Low ability workers
If education has no effect on productivity, what is the outcome?
DWL
How do you find the net surplus from acquiring education for high income workers?
Wage - cost of education
What are the key features of separating signalling equilibrium?
- Competing firms make 0 profit
What is the wage rate for low ability workers equal to?
Their marginal value