The Economics of Information Flashcards
1
Q
What is the variance of x?
A
- 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
2
Q
What is the variance and std?
A
- The variance is a common measure of risk
- The Standard deviation is the square root of the variance = σ
3
Q
What is the expected utility theorem?
A
- 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)
4
Q
What is risk averse?
A
A risk averse individual prefers a sure amount of $M to a lottery with an expected value of $M
5
Q
What is risk loving?
A
A risk loving individual prefers a lottery with an expected value amount of $M to a sure amount of $M
6
Q
What is consumer search?
A
- 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
7
Q
What is profit max under uncertainty?
A
- 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
8
Q
What is asymmetric information?
A
- Some parties to a trade possess more knowledge about the characteristics of the object of trade
9
Q
What are the components of asymmetric information?
A
- 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
10
Q
How can the information problem be overcome?
A
- Signalling
* Screening
11
Q
What is signalling?
A
- The parties with superior information takes some action to signal or reveal their hidden characteristics
- e.g. product warranty, educational qualification
12
Q
When is signalling effective?
A
- 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
13
Q
What is a signalling eqm?
A
- Refers to the equilibrium where different types of agents choose different options
- Thus by observing the agent’s choice, its type is revealed
14
Q
What is a pooling eqm?
A
- 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
15
Q
What are the possible outcomes of signalling?
A
- Singling equilibrium
* Pooling equilibrium
16
Q
What is screening?
A
- 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
17
Q
How can screening be achieved?
A
- 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
18
Q
What are examples of when screening is possible?
A
- 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
19
Q
What are auctions?
A
- 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
20
Q
What are the differences between the different types of auctions?
A
- Timing of bidder decision (simultaneous or sequential)
- The amount the winner is required to pay
21
Q
What is an English auction?
A
- 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
22
Q
What is a first price, sealed bid auction?
A
- 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
23
Q
What is a second price, sealed bid auction?
A
- 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
24
Q
What is a Dutch auction?
A
- 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
25
What auction types are strategically equivalent?
- 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
26
What are the information structures in regards to auctions?
- 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
27
What are independent Private Value Auctions?
- Bidders know they own valuations prior to the auction start
28
What is the optimal strategy for an English auction with Independent Private Values?
- Remain active until the price exceeds their own valuation
29
What is the optimal strategy for an Second price, sealed bid auction with Independent Private Values?
- 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
30
What is the optimal strategy for a Dutch OR first price, sealed bid auction with Independent Private Values?
- Bid true valuation: expected payoff always zero
| - Bid less than true valuation
31
What is a correlated value auction and what is the implication?
- 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
32
How can the winner's curse be avoided?
- 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
33
How does the winner's curse affect different auction types?
- 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)
34
How is expected demand calculated?
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
35
What is important about the order of calculations in Oligopoly questions?
Don't work out profits before you have both quantities - P dependent on total market Q
36
How is the Limit Price found?
π2(as a function of q1) = 0
37
What is π1 as a function of q2?
p.(BR(q1)+q2)) - TC
38
What is the difference between x now, y forever and x now and forever?
x now, y forever: x + y/r
x now and forever: x(1+r/r)
39
What should be asked of predatory pricing?
P required
