Session 9: Information Asymmetry Flashcards
What is asymmetric information?
Inbalance of information about products and services between buyers and sellers. Sellers often have better information.
What are some reasons for asymmetric information?
Experts know more about their skills than customers
Complicated contracts
Unobserved quality
Experience goods (ie movies, theme parks)
What does asymmetric information create?
Market distortion
What is adverse selection?
When the quality of the product or service in a market is hidden
What are the conditions of adverse selection?
Over supply of low quality
Under supply of high quality
What happens to high quality products in a market for lemons?
Customer doesn’t know quality, assumes the quality is average
Lower quality products drive out higher quality products
What are the common solutions for adverse selection?
Signaling
Screening
Monitoring
What is signaling?
When an informed agent signals their true product or service quality (good or bad)
When are signals effective?
They’re only effective if they are costly
Only the good type can signal
What is screening?
Process that gets people to reveal their private information
Who performs signaling?
Agent, or seller
Who performs screening?
Uninformed actor
What is monitoring?
Requiring applicants to provide verifiable information, with the hope that the information is correlated with quality
What is moral hazard?
The assumption that people will act in ways that benefit themselves, but their actions are not observable.
What is the principal-agent problem?
Principal hires an agent, but cannot monitor perfectly
