Imperfect info / public goods Flashcards
What is Asymmetric information?
when a buyer knows more about a product than the seller (vice versa)
- the under informed party can only monitor the behavior of the other party at a cost
What is buyers reservation price?
maximum the buyer will pay
What is sellers reservation price?
minimum the seller will accept
How do you calculate the buyers risk-neutral price?
(0.5 x reservation price of bad good) + (0.5 x reservation price of good good)
What is adverse selection?
an uninformed party to a contract ends up trading with the wrong people
(some strategies to stop adverse selection, but they come at a cost to the consumer)
What does asymmetric information lead to?
Asymmetric information leads to adverse selection - eventually leads to market failure
How do you calculate a premium?
(COST OF THE EVENT / PROBABILITY OF IT OCCURING)
How do firms try to stop adverse selection?
attempt to buy their clients into separate risk groups
- Based on information learnt (medical records not provided, etc)
What is moral hazard?
(example) people who have insurance are more likely to change their behavior as a result of having the insurance (eg driving faster) - they don’t bear the full cost of the accident
-
What is a solution to moral hazard? (premium)
incentivizing people by passing more of the cost on to those who claim. - lose your no claims bonus. - premium becomes more expensive. Charge an excess - insured party pays the 1st x $$ of a claim
When would a high risk group take insurance? What does this mean for a firm?
when the premium is cheaper than what they would pay
○ Rate of operations is now higher because the customers are predominately high risk - the seller (insurance company) loses money
○ market failure due to adverse selection
What is a Rival good?
once one person has it, no on else can
What is the marginal cost of production of a Rival good?
greater than 0 (can be used up)
What is a Non Rival good?
once one person has it,it is available for other to consume
What is the marginal cost of production of a Non Rival good?
tends to have a marginal cost of 0
(capacity for others)
What is an Excludable good?
a firm can stop consumers from using the good if they haven’t paid for it
What is a Non Excludable good?
people can’t be stopped from using it
What does/n’t the market work well for?
The private market works well for Excludable goods most of the time
Doesn’t work so well for Non Excludable goods
What is a common resource?
A RIVAL, NON EXCLUDABLE good
(deep sea fishing)
What is a pure public good?
A NON RIVAL, NON EXCLUDABLE good
(footpath)
What is a pure private good?
A RIVAL, EXCLUDABLE good
(haircut)
What is a private good?
A NON RIVAL, EXCLUDABLE good
(empty seats on a bus)
What is the nature of Public Goods?
pure public goods + common resources
- are usually under-provided by markets
- hard to make profit from them (free rider problem)
- Tend to be provided by local or central government
What do common resources suffer from?
Overuse - they can be used up, but you can’t stop people from using them
- Free rider problem
