Ch11-12 : Asymmetric Information Flashcards
What is an asymmetric information?
It’s when a person has accès to economically relevant information that is not know by all.
An agent with a better information has comparative advantage to other parties and can use this information to modify his actions or choices in his favour
Asymmetric information leads to market failure
What are the 2 concepts related to asymmetric information ?
Adverse selection
Moral hazard
What is an adverse selection ?
It’s a situations in which the asymmetric information is related to hidden information
What is a moral hazard ?
It’s a situation in which the asymmetric information is related to hidden actions
In adverse selection, what are the three possible scenarios ?
Perfect information : buyers and seller can observe the quality of each car
Total ignorance : no one can observe the quality of the cars
Asymmetric information : only sellers know the quality of the cars
When does occurs adverse selection ?
It occurs when the agent with a hood of the highest value self-selects out of the trade
There is a selection of the types of owners willing to sell, and an “adverse” one at that : these are the owners with the low valuation
What are solutions to the problem of adverse selection?
Signaling : adding a cost
Screening : contracts, tests
Certification : transmit info to the uninformed
Brands and reputation : quality of product
Regulation : involves the gouvernement
What is the problem of adverse selection ?
An agent with high value or high quality hood may choose to exclude himself from the transaction
Many beneficial trade opportunities are lost, resulting in inefficient allocation ( market failure )
If a buyer have an EV < the willingness to sell from a seller what happen?
The buyers will anticipated that no good cars will be sold then they will reduced their willingness to pay to the price their WTP for lemons. This is cause by adverse selection
The adverse selection in health insurance markets refers to…
The tendency of low risk people to opt out of insurance, increasing the price of insurance
This will eventually lead to a total collapse of the market (death spiral)
If it’s a perfect information situation how to we deal with that?
Compare WTP of the buyers with the WTA of the sellers
If WTP > WTA all cars will be sold
If it’s an asymmetric information situation how to we deal with that ?
Compare the EV of the buyer with the WTA of the seller
If EV > WTA all cars will be sold
If EV < WTA the cars won’t be sold and buyers will anticipated and reduces its price to their WTP
What are examples of market suffering from the adverse selection problem ?
Insurance market
Labour market
Credit market
What is a moral hazard ?
It’s a situation in which an individual takes a hidden action that benefits him at the expense of another party.
This hidden action has consequences for all agents, including those who do not observe it, moral hazard can create economic distortions
What is the relation principal-agent?
Agent : a person who acts (employees)
Principal : party affected by the actions (employer)
The problem comes from the fact that the principal cannot observe of the actions of the agent (the effort level), only his performance
