The Economics of Information

Question 1

What is the variance of x?

Answer 1

• σ^2 = q1(x1 - E(x))^2 + q2(x2 - E(x))^2 + … + qn(xn - E(x))^2
• If xn denote the possible outcomes of the random variable x and qn the corresponding probabilities of the outcomes, and E(x) the expected value of x

Question 2

What is the variance and std?

Answer 2

• The variance is a common measure of risk

- The Standard deviation is the square root of the variance = σ

Question 3

What is the expected utility theorem?

Answer 3

• We assume that in addition to utility function representation of our consumer’s preferences, our consumer’s presences under uncertainty can be represented by expected utility
• Eu(x) = q1u(x1) + q2u(x2) + … + qnu(xn)
• A > B if and only if Eu(A) > Eu(B)

Question 4

What is risk averse?

Answer 4

A risk averse individual prefers a sure amount of $M to a lottery with an expected value of $M

Question 5

What is risk loving?

Answer 5

A risk loving individual prefers a lottery with an expected value amount of $M to a sure amount of $M

Question 6

What is consumer search?

Answer 6

• To identify the low-price seller from among many firms selling an identical product, consumers sometimes incur a cost, c, to obtain each price quote
• After observing each price quote a consumer must weigh the expected benefit from acquiring an additional price quote with the additional cost
• The same principle applies to firms who search for inputs with different prices

Question 7

What is profit max under uncertainty?

Answer 7

• If demand and revenue is uncertain and the manager is risk neutral, the manager will want to maximise expected profits by producing the output where the expected marginal revenue equals marginal cost
• E(MR) = MC

Question 8

What is asymmetric information?

Answer 8

• Some parties to a trade possess more knowledge about the characteristics of the object of trade

Question 9

What are the components of asymmetric information?

Answer 9

• Hidden information (Adverse Selection)
  
  • Adverse selection refers to situations where individuals have hidden characteristics
  • A selection process results in a pool of individuals with undesirable characteristics
    
    • In this context the hidden characteristic is known by one party but cannot be observed but he other party
• Hidden Action (Moral Hazard)
  
  • Moral hazard refers to a situation where one party to a contract takes a hidden action that benefits oneself at the expense of another party
  • Principal agent problem

Question 10

How can the information problem be overcome?

Answer 10

• Signalling

* Screening

Question 11

What is signalling?

Answer 11

• The parties with superior information takes some action to signal or reveal their hidden characteristics
• e.g. product warranty, educational qualification

Question 12

When is signalling effective?

Answer 12

• Must be observable by the uninformed party
• Must be a reliable indicator of the unobseravle characteristics and difficult for parties with other characteristics to easily mimic
  
  • To communicate information credibly, a signal must be costly or difficult to fake
  • e.g. extensive warranty

Question 13

What is a signalling eqm?

Answer 13

• Refers to the equilibrium where different types of agents choose different options
  
  • Thus by observing the agent’s choice, its type is revealed

Question 14

What is a pooling eqm?

Answer 14

• Both types of agents make the same choice in equilibrium
• By observing the behaviour, no information is revealed about the agent
• If conditions * and ** are not satisfied, the eqaulibirum would be that no warranty is offered
• There is no signal, and the buyer does not get to infer the quality of the car

Question 15

What are the possible outcomes of signalling?

Answer 15

• Singling equilibrium

* Pooling equilibrium

Question 16

What is screening?

Answer 16

• The uninformed party takes some action to identify the product or the other party’s characteristics
• e.g. insurance with different level or premium, excess clauses in insurance premiums with low premia

Question 17

How can screening be achieved?

Answer 17

• Screening may be achieved through a self-selection
  
  • The uninformed party presents the informed party with a menu of different options
  • Designed such that different types of agents will choose different options
  • And thus reveal their types
  • Second degree price discrimination

Question 18

What are examples of when screening is possible?

Answer 18

• Business travellers and leisure travellers have different PED
• Airline companies typically cannot identify different types of travellers directly
• Offer super saver fare and flexible fare and let the two types self select and reveal their types
• Another popular instrument is air tickets which require night stay over

Question 19

What are auctions?

Answer 19

• A mechanism where potential buyers compete for an object or some the right to own a good
• Sellers participating in an auction offer an item for sale, and wish to obtain the highest price

Question 20

What are the differences between the different types of auctions?

Answer 20

• Timing of bidder decision (simultaneous or sequential)

- The amount the winner is required to pay

Question 21

What is an English auction?

Answer 21

• An ascending sequential-bid auction where bidders observe the bids of others and decide whether or not to increase the bid
• The auction ends when a single bidder remains
• This bidder obtains the item and pays the auctioneer the amount of the bid
• Bidders continually obtain information about one another’s bids
• Bidder who values the item the most will win

Question 22

What is a first price, sealed bid auction?

Answer 22

• A simultaneous move auction in which bidders simultaneously submit bids to an auctioneer
• The auctioneer awards the item to the highest bidder, who pays the amount bid
• Bidders obtain no information about one another’s bids
• Bidder who values the item the most will win

Question 23

What is a second price, sealed bid auction?

Answer 23

• A simultaneous-move auction in which bidders simultaneously submit bids to an auctioneer
• The auctioneer awards the item to the highest bidder, who pays the amount bid by the second-highest bidder
• Bidders obtain no infmroaitno abut one another’ sbids
• Bidder who values the item the most will win, but pays the second-highest bid

Question 24

What is a Dutch auction?

Answer 24

• A descending sequential bid auction in which the auctioneer begins with a high asking price and gradually reduces the asking price until one bidder announces a willingness to pay that price for the item
• Bidders obtain no information about one another’s bids through the auction process
• Bidder who values the item the most will win and pays the amount of their bid

Question 25

What auction types are strategically equivalent?

Answer 25

• The dutch and first price sealed bid auctions are strategically equivalent; that is, the optimal bids by participants are identical for both types of auctions
• No information about other bidders is available until the auction is over
• The highest bidder pays the amount of their bid

Question 26

What are the information structures in regards to auctions?

Answer 26

• While the four auction types differ with respect to the information bidders have about the bids of other bidders, the information structures about bidders valuation of the object may also be different
• Perfect information
• Independent private values
• Affiliated (or correlated) value estimates
  
  • Special case: common-value auctions
  • e.g. bidding for mining rights

Question 27

What are independent Private Value Auctions?

Answer 27

• Bidders know they own valuations prior to the auction start

Question 28

What is the optimal strategy for an English auction with Independent Private Values?

Answer 28

• Remain active until the price exceeds their own valuation

Question 29

What is the optimal strategy for an Second price, sealed bid auction with Independent Private Values?

Answer 29

• Bid their own valuation. This is a (weakly) dominant strategy
• Does not pay to bid higher or lower than true valuation
  
  • If lower, only decrease probability of winning, not price that will be paid

Question 30

What is the optimal strategy for a Dutch OR first price, sealed bid auction with Independent Private Values?

Answer 30

• Bid true valuation: expected payoff always zero

- Bid less than true valuation

Question 31

What is a correlated value auction and what is the implication?

Answer 31

• Bidders to not know their own valuations for an item, nor others’ valuations
  
  • Implication: makes bidder vulnerable to the winners curse, which is the ‘bad news’ conveyed to the winner that his or her estimate of the item’s value exceeds the estimates of all other bidders, and exceeds the true value of item

Question 32

How can the winner’s curse be avoided?

Answer 32

• To avoid the winner’s curse in a common value auction, a bidder should revise downward his or her private estimate of the value to account for this fact

Question 33

How does the winner’s curse affect different auction types?

Answer 33

• The winner’s curse is most pronounced in sealed-bid auctions since bidders don’t learn about other player’s valuations. More incentive to bid under their valuation
• English auctions, in contrast, provide bidders with information. Therefore, less incentive to bid under their estimate (Pooling information)

Question 34

How is expected demand calculated?

Answer 34

E(D): E(P) = (P(a - bQ)) + (1-P(x - zQ))

i.e. literally just times the P and 1-P by the values in the demand functions

Question 35

What is important about the order of calculations in Oligopoly questions?

Answer 35

Don’t work out profits before you have both quantities - P dependent on total market Q

Question 36

How is the Limit Price found?

Answer 36

π2(as a function of q1) = 0

Question 37

What is π1as a function of q2?

Answer 37

p.(BR(q1)+q2)) - TC

Question 38

What is the difference between x now, y forever and x now and forever?

Answer 38

x now, y forever: x + y/r

x now and forever: x(1+r/r)

Question 39

What should be asked of predatory pricing?

Answer 39

P required