Ch. 19 - Decisions Involving Private Information

Question 1

What is priviate information?

Answer 1

When one party to a transaction knows something the other doesn’t

Question 2

What is adverse selection of sellers?

Answer 2

The tendancy for the mix of goods to be skewed toward more low-quality goods when buyers can’t observe quality

Question 3

What is adverse selection of buyers?

Answer 3

The tendancy for the mix of buyers to be skewed toward more high-cost buyers when sellers don’t know buyers’ type

Question 4

What are the solutions to adverse selection of sellers?

Answer 4

1. Buyers can learn from third-party verifiers
2. Sellers can signal their product’s quality
3. Government can increase information or weed out low-quality goods

Question 5

What are the solutions to adverse selection of buyers?

Answer 5

1. Sellers can use info that is related to the buyer’s likely costs
2. Sellers can offer different contracts so that buyers separate themselves
3. Government can increase info or directly reduce adverse selection

Question 6

What is a moral hazard?

Answer 6

The actions you take because they are not fully observable and you are partially insulated from their consequence

Question 7

What is the principal-agent problem?

Answer 7

The problems that arise when a principal hires an agent to do something on their behalf, but the principal cannot perfectly observe the agent’s actions

Question 8

What are the 5 solutions to moral hazard?

Answer 8

1. Make hidden actions observable by monitoring
2. Provide complements that go with the actions you want
3. Give people a stake in the outcome
4. Government rules & social norms can help align incentives
5. Pick the right kind of agents

Question 9

What is pay-for-performance?

Answer 9

Linking the income your workers earn to measures of their performance (ex. commisions, piece rates, bonuses, or promotions)