Signalling

Question 1

What is adverse selection?

Answer 1

When sellers in a market have information that buyers do not have

Question 2

What do high quality traders need to be able to do in order to trade?

Answer 2

Persuade consumers of their true quality

Question 3

High quality agents want their private information to become…

Answer 3

Common knowledge

Question 4

Why are costless statements about high quality not credible?

Answer 4

Low quality firms would be able to mimic the same statements

Question 5

What is cheap talk?

Answer 5

Costless statements that provide no extra information to consumers and are useless to them

Question 6

What is an example of a business being able to prove quality?

Answer 6

A business obtaining a star rating or food hygiene rating

Question 7

What could a high quality firm do to drive away low quality firms?

Answer 7

Do something it isn’t optimal for low quality firms to mimic

Question 8

What is a separating equilibrium?

Answer 8

where the two types of agents behave differently and allow the consumer to correctly infer the quality of their products/production

Question 9

If the quality is high in period 1, the producer can sell in period 2 without…

Answer 9

the producer can sell and charge price 0bar in period 2 without advertising, due to the period 2 purchase being a repeat purchase by the consumers from period 1

Question 10

Why might a low type producer earn zero profits? (behaviour)

Answer 10

A low type producer can sometimes earn zero profits, because they do not carry out any advertising or signalling of their quality, so consumers recognise them as low quality and do not buy.

Question 11

Explain why a low type producer earns ((0bar – CL) – A)

Answer 11

A low type producer earns obar – CL – A, because consumers pay price 0bar in period 1, which the producer earns minus the cost of producing the low quality good (CL), then they also have the advertising cost A that the spent attracting the consumer to purchase.

Question 12

What are the requirements for a separating equilibrium?

Answer 12

• The low type is not willing to mimic the high type

- The high type is willing to signal it’s quality

Question 13

How can a high type signal quality?

Answer 13

If the low type is not willing to mimic the high type, and the high type is willing to signal, then the high type can signal by carrying out costly advertising.

Question 14

Why does advertising boost welfare in a separating equilibrium?

Answer 14

In a separating equilibrium, advertising boosts welfare because it enables consumers to trade with a high-quality type.

Question 15

How does asymmetric information in a separating equilibrium damage social welfare?

Answer 15

Asymmetric information in a separating equilibrium can still damage social welfare, because the high type producers have to spend on advertising to prove their quality, so incurs higher costs which reduce their profits.

Question 16

What is a pooling equilibrium?

Answer 16

A pooling equilibrium is when the two producer types behave similarly, so consumers cannot tell them apart and the adverse selection problem remains

Question 17

What is “Burning money”?

Answer 17

Burning money is the process of carrying out advertising that is observably costly, rather than carrying it out for the information it contains. High type firms can use it to signal their worth and quality to consumers.

Question 18

Workers differ in … levels, and employers do not observe the … levels of prospective workers

Answer 18

Workers differ in productivity levels, and employers do not observe the productivity levels of prospective workers

Question 19

The existence of … … workers dampens the … … rate

Answer 19

The existence of low productivity workers dampens the equilibrium wage rate

Question 20

How can high productivity workers signal their worth?

Answer 20

High productivity workers can signal their worth by spending money on certificates that prove their skill, such as a degree or training course.

Question 21

What are the stages of the wage signalling game?

Answer 21

• Workers each learn their own type
• Workers each then choose an education level, y
• Firms observe education levels and each decide on a wage offer schedule w(y) simultaneously
• Workers each choose a wage offer

Question 22

What is the concept of the full information benchmark?

Answer 22

The concept of the full information benchmark is when productivity is common knowledge, and competition for the most productive workers pushes all wages up to match their productivity levels

Question 23

If productivity information is asymmetric, firms pay at the … productivity wage rate

Answer 23

If productivity information is asymmetric, firms pay wages at the expected level of productivity

Question 24

In this wage market separating equilibrium, the two worker types select different … levels

Answer 24

In this wage market separating equilibrium, the two worker types select different education levels to allow firms to distinguish between them

Question 25

What are the 3 properties of equilibrium in this wage market?

Answer 25

• Workers must select education optimally, given other players’ behaviours and firm’s beliefs
• Firms must select wage offers optimally, given other players’ behaviours and firms beliefs
• Firms must hold correct beliefs about each worker’s productivity given their education level

Question 26

In a separating equilibrium, the … types do not want to … the … types

Answer 26

In a separating equilibrium, the low types do not want to mimic the high types, mainly due to the cost of doing so (£9,500 tuition fees etc)

Question 27

What are the cost and wage implications for low type workers of the wage market signalling condition?

Answer 27

low type workers incur a lower cost of obtaining a job, but are paid a lower wage. In contrast, high type workers incur a higher cost of obtaining a job (time as well as money?) but earn a higher wage once employed, and may have higher obtainable career levels within companies.

Question 28

Why does a separating equilibrium require the level of education to be sufficiently large?

Answer 28

A separating equilibrium requires the level of education to be sufficiently large, because otherwise it would be easy for low type workers to mimic/imitate a high type worker

Question 29

What is a least cost separating equilibrium?

Answer 29

A least cost separating equilibrium is when the cost of obtaining proof of being a high type agent is the minimum level to discourage low type workers from imitating.

Question 30

In the case of asymmetric information, low types prefer … …

Answer 30

In the case of asymmetric information, low types prefer no signalling

Question 31

Whether society is better off or not under signalling depends upon the …

Answer 31

Whether society is better off or not under signalling depend upon the restrictions of the market