Chapter 16

Question 1

What is complete information?

Answer 1

This is a situation in which every market participant knows everything important for making economic decisions.

Question 2

What is asymmetric information?

Answer 2

This is a situation in which there is an imbalance of information across participants in an economic transaction.

Question 3

What is a lemons problem?

Answer 3

This is an asymmetric information problem that happens when seller knows more about the quality of the good he is selling than the buyer.

Question 4

What is adverse selection?

Answer 4

This is a situation where there are stronger incentives for bad quality products to be involved in a transaction than good types. It ends up hurting both parties of the transaction.

Question 5

Name three ways to mitigate adverse selection from the buyers side

Answer 5

1. Group policies: spread risk over multiple types of a product/group
2. Screening, this way the seller gets to know more about the buyers and reduce asymmetric information.

Question 5

Name three mechanisms to mitigate the lemons problem?

Answer 5

1. Reducing asymmetric information directly
2. Incentives for truthful quality reporting (reputation)
3. Increasing average quality of product placed on the market.

Question 5

What is moral hazard?

Answer 5

This is a situation where one party in an economic transaction cannot observe another party’s behavior

Question 6

What are principal-agent relationships?

Answer 6

These are economic transactions featuring information assymetry between the principal and agent, whose actions cannot be fully observered by the principal.

Question 7

What is the principal-agent problem?

Answer 7

Problem that occurs when the interests of the principal and agent are misaligned. Agents can be incentivized to act in interest of principal, but this should be tied to something observable.

Question 8

What is signalling?

Answer 8

This is a solution to the problem of asymmetric information in which the knowledgeable party alers the other party to an unobservable characteristic of the good. This signal conveys what would have been unknown information about the signal sender. The cost must be less costly for the better product than for the lower quality product.

Question 9

What is a signal?

Answer 9

This is a costly action taken by an economic actor to indicate something that would otherwise have been difficult to observe.