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MICROECONOMICS: Theory & Applications
Chapter 14 Game Theory and the Economics of Information
By Edgar K. Browning & Mark A. ZupanJohn Wiley & Sons, Inc.9th Edition, copyright 2006PowerPoint prepared by Della L. Sue, Marist College
Copyright 2006John Wiley & Sons, Inc.14-2
Game Theory
Game theory – a method of analyzing situation in which the outcomes of your choices depend on others’ choices, and vice versa
Elements common to all game theory:– Players – decision makers whose behavior we are trying to
predict and/or explain– Strategies – the possible choices of the players– Payoffs – the outcomes or consequences of the strategies
chosen
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Repeated Games
Repeated Game Model – a game theory model in which the “game” is played more than once
Tit-for-tat – a strategy in which each player mimics the action taken by the other player in the preceding period
Table 14.6
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Asymmetric Information
Imperfect information – the case when market participants lack some information relevant to their decisions
Asymmetric information – a case in which participants on one side of the market know more about a good’s quality than do participants on the other side
The “Lemons” Model
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Market Responses to Asymmetric Information
Information is a scarce good. The benefits from acquiring information about
product quality will not always be worth its costs.
It might be efficient for consumers to be less than fully informed.
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Adverse Selection
Adverse selection – a situation in which asymmetric information causes higher-risk customers to be more likely to purchase or sellers to be more likely to supply low-quality goods
Application – insurance markets in which the assumption of full information (both firms and customers know the risks) is modified
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Market Responses to Adverse Selection
Key: there are potential gains to market participants from adjusting their behavior to account for the adverse selection problem
Examples:– Upper limit on insurance coverage– Requirement of physical exams and/or a waiting
period – Group plans covering all employees
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Moral Hazard
Moral hazard – a situation that occurs when, as a result of having insurance, an individual becomes more likely to engage in risky behavior
The problem arises when insurance companies lack knowledge of the actions people take that may affect the occurrence of unfavorable events.
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Market Responses to Moral Hazard
Example: medical insurance market– Limitation on the services covered by insurance– Requirement of the insured person to pay part of
the costs: Coinsurance rate – the share of the cost borne by the
patient
– Deductibles – the amount that the patient must pay before insurance coverage is effective
Copyright 2006John Wiley & Sons, Inc.14-10
Limited Price Information
Price dispersion – a range of prices for the same product, usually as a result of customers’ lacking price information
Search costs – the costs that customers incur in acquiring information
Price dispersion will fall when the benefit from search is higher than the cost.
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Advertising, the Full Price of a Product, and Market Efficiency
Full price – the sum of the money price and the search costs that consumers incur
Advertising is a substitute for the consumer’s own search efforts, and thereby reduce search costs.
Advertising is a low-cost way of conveying information, and thereby increases market efficiency.
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Advertising and Its Effects on Products’ Prices and Qualities
Firms advertise to provide information to customers.
Effects of advertising:– Reduce price dispersion and lower the average
price– Solve the lemons problems by giving high-quality
sellers an advantage over low-quality sellers– Introduce consumers to new products
MICROECONOMICS: Theory & Applications
Chapter 16 Employment and Pricing of Inputs
By Edgar K. Browning & Mark A. ZupanJohn Wiley & Sons, Inc.9th Edition, copyright 2006PowerPoint prepared by Della L. Sue, Marist College
Copyright 2006John Wiley & Sons, Inc.14-14
The Firm’s Demand Curve: One Variable Input
Marginal value product (MVP) – the extra revenue a competitive firm receives by selling the additional output generated when employment of an input is increased by one unit
MVP curve = firm’s demand curve for a given input when all other inputs are fixed
Wage rate = MVPL=MPL*P Figure 16.1 (Continued)
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The Firm’s Demand Curve: One Variable Input (continued)
Assumption: The firm is a profit maximizer in a competitive market
Conclusions:– The marginal value product curve identifies the
most profitable employment level for the input at each alternative cost.
– The marginal value product curve slopes downward.
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The Firm’s Demand Curve: All Inputs Variable
In general, a change in an input’s price leads a firm to also alter its employment of other inputs.
Long-run demand curve Assume that other inputs’
prices are unchanged. Final product’s price is
constant. Figure 16.2
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The Supply of Inputs
The general shape of an input supply curve depends critically on the market for which the supply curve is drawn.
Figure 16.5
MICROECONOMICS: Theory & Applications
Chapter 20 Public Goods and Externalities
By Edgar K. Browning & Mark A. ZupanJohn Wiley & Sons, Inc.9th Edition, copyright 2006PowerPoint prepared by Della L. Sue, Marist College
Copyright 2006John Wiley & Sons, Inc.14-19
Public Goods and Externalities
Public goods – those goods that benefit all consumers
Externalities – the harmful or beneficial side effects of market activities that are not fully borne or realized by market participants
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What Are Public Goods?
Characteristics:– Nonrival in consumption – a condition in which a good with a
given level of production, if consumed by one person, can also be consumed by others
– Nonexclusion – a condition in which confining a good’s benefits, once produced, to selected persons is impossible or prohibitively costly
Free-Rider Problem– A consumer who has an incentive to underestimate the value
of a good in order to secure its benefits at a lower, or zero, cost– As the group size increases, it is more likely that everyone will
behave like a free rider, and the public good will not be provided.
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Externalities
External benefits – positive side effects of ordinary economic activities
External costs – negative side effects of ordinary economic activities
Distinction between externalities and public goods:– External effects are unintended side effects of activities
undertaken for other purposes.– Both are likely to lead to an inefficient allocation of resources.