Signalling Flashcards
What is adverse selection?
When sellers in a market have information that buyers do not have
What do high quality traders need to be able to do in order to trade?
Persuade consumers of their true quality
High quality agents want their private information to become…
Common knowledge
Why are costless statements about high quality not credible?
Low quality firms would be able to mimic the same statements
What is cheap talk?
Costless statements that provide no extra information to consumers and are useless to them
What is an example of a business being able to prove quality?
A business obtaining a star rating or food hygiene rating
What could a high quality firm do to drive away low quality firms?
Do something it isn’t optimal for low quality firms to mimic
What is a separating equilibrium?
where the two types of agents behave differently and allow the consumer to correctly infer the quality of their products/production
If the quality is high in period 1, the producer can sell in period 2 without…
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
Why might a low type producer earn zero profits? (behaviour)
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.
Explain why a low type producer earns ((0bar – CL) – A)
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.
What are the requirements for a separating equilibrium?
- The low type is not willing to mimic the high type
- The high type is willing to signal it’s quality
How can a high type signal quality?
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.
Why does advertising boost welfare in a separating equilibrium?
In a separating equilibrium, advertising boosts welfare because it enables consumers to trade with a high-quality type.
How does asymmetric information in a separating equilibrium damage social welfare?
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.
What is a pooling equilibrium?
A pooling equilibrium is when the two producer types behave similarly, so consumers cannot tell them apart and the adverse selection problem remains
What is “Burning money”?
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.
Workers differ in … levels, and employers do not observe the … levels of prospective workers
Workers differ in productivity levels, and employers do not observe the productivity levels of prospective workers
The existence of … … workers dampens the … … rate
The existence of low productivity workers dampens the equilibrium wage rate
How can high productivity workers signal their worth?
High productivity workers can signal their worth by spending money on certificates that prove their skill, such as a degree or training course.
What are the stages of the wage signalling game?
- 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
What is the concept of the full information benchmark?
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
If productivity information is asymmetric, firms pay at the … productivity wage rate
If productivity information is asymmetric, firms pay wages at the expected level of productivity
In this wage market separating equilibrium, the two worker types select different … levels
In this wage market separating equilibrium, the two worker types select different education levels to allow firms to distinguish between them
