Chapter 17 - Uncertainty and Asymmetric Information Flashcards
payoff
The amount that comes from a possible outcome or result.
expected value
The sum of the payoffs associated with each possible outcome of a situation weighted by its probability of occurring.
fair game or fair bet
A game whose expected value is zero.
diminishing marginal utility
The more of any one good consumed in a given period, the less incremental satisfaction is generated by consuming a marginal or incremental unit of the same good.
expected utility
The sum of the utilities coming from all
possible outcomes of a deal, weighted by the probability of each occurring.
risk-averse
Refers to a person’s preference of a certain
payoff over an uncertain one with the same expected value.
risk-neutral
Refers to a person’s willingness to take a bet with an expected value of zero.
risk-loving
Refers to a person’s preference for an uncertain deal over a certain deal with an equal expected value.
risk premium
The maximum price a risk-averse person will
pay to avoid taking a risk.
asymmetric information
One of the parties to a transaction has information relevant to the transaction that the other party does not have.
adverse selection
A situation in which asymmetric information results in high- quality goods or high-quality consumers being squeezed out of transactions because they cannot demonstrate their quality.
market signaling
Actions taken by buyers and sellers to communicate quality in a world of uncertainty.
moral hazard
Arises when one party to a contract changes behavior in response to that contract and thus passes on the costs of that behavior change to the other party.
mechanism design
A contract or an institution that aligns the interests of two parties in a transaction. A piece rate, for example, creates incentives for a worker to work hard, just as his or her superior wants. A co-pay in the health care industry encourages more careful use of health care, just as the insurance company wants.
