Moral hazard

Question 1

What is private information?

Answer 1

Information that only a subset of players know

Question 2

When does a moral hazard arrive?

Answer 2

When one side of the market cannot observe the actions of the other side

Question 3

What is adverse selection?

Answer 3

When one side of the market cannot observe the types or characteristics of players on the other side of the market

Question 4

What are some examples of when asymmetric information arises?

Answer 4

• Financial situations
• Government/politics
• Workplace
• Social relationships

Question 5

What is a search good?

Answer 5

Consumers can fully predict the utility from consuming the good, pre purchase

Question 6

Under full information, what quality and price would a monopolist choose?

Answer 6

Under full information, a monopolist would choose quality S = 1, and price of θ (maximum a consumer is willing to pay)

Question 7

Why would a one shot rational consumer only want to pay a low quality price?

Answer 7

Because the consumer can predict that firms have an incentive to produce s = 0 at a lower cost, and so expect a lower quality

Question 8

What grim trigger strategy situation will lead to a high quality outcome?

Answer 8

One in which the consumer buys and keeps buying until he obtains a low-quality product

Question 9

Why are repeated interactions important in overcoming market failures?

Answer 9

Because it leads to repeat purchases (e.g. poor service station quality).