Intro to Economics - Information
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Transcript of Intro to Economics - Information
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8/3/2019 Intro to Economics - Information
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Information Economics
Dr. Katherine Sauer
A Citizens Guide to Economics
ECO 1040
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Overview:
I. Information Asymmetry
II. Private Solutions
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I. Asymmetric Information
- a situation where parties have a difference in theiraccess to relevant knowledge
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What was the Hope Scholarship Program?
Why was it doomed to fail?
What does this have to do with information?
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When information asymmetry is too large, marketsmay not functionproperly.
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2 Basic Types of Asymmetric Information
1. Hidden Actions
One partys behaviorcannot be fully observed by
another party.
2. Hidden Characteristics
Afeature of a product or person is unknown to another
party.
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1. Hidden Actions
When someones actions are not fully observable by
another party, problems can arise.
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Moral Hazard is when a party protected from risk
behaves differently than it would behave if it were fully
exposed to the risk.
- tendency to act less carefully when not bearing
full consequences of an action
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Examples:
- a person with automobile insurance
may be less cautious about locking car
may park in more dangerous areas
because: negative consequences of vehicle theft
are partially the responsibility of the insurance
company
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- a renter
may be less diligent about checking their
residence for mold
may be less careful about keeping the carpets
clean
because: they arent the long run owners
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Moral Hazard is a key feature of the principal-agent
problem.
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2. Hidden Characteristics
Some of the characteristics of a person or object can not
be fully observed.- person has a pre-disposition to cancer
- used car has a transmission that is about to fail
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Adverse Selection is the tendency for the mix of
unobserved attributes to become undesirable from the
standpoint of the uninformed party.
Explain adverse selection using the market for lemons.
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Example:
People who have health issues are also the ones who most
want health insurance.
- from the point of the insurance firm, there is
adverse selection of people to insure
How is information asymmetry present in the health care
market?
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Hidden Actions vs Hidden Characteristics
A person who is not fully monitored may take actions that
are undesirable from the point of view of the uninformed
party.
- hidden action- principle-agent type problems
A person or product may have an inherent quality that is
viewed as undesirable from the point of view of theuninformed party.
- hidden characteristic
- adverse selection problems
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II. Private Solutions
1. Signaling is an action taken by an informed party to
reveal private information to an uninformed party.
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Examples:
- college degree
- Car Fax report for used vehicle
- the clothes you wear
- branding by businesses
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How does branding help consumers?
How does branding help firms?
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2
. Screening is an action taken by an uninformed partyto induce an informed party to reveal information.
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Examples:
- take a used car to a mechanic before buying
- insurance gives you choice of deductibles
- employer advertises that they do mandatory drug
testing
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Additionally, the uninformed party could provide
incentives for the informed party to act in a certain
way.
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Problem: renters not taking good care of apartment
- the main reason is because they dont have any long-term stake in the property
- charging a security deposit gives renters an incentive to
care for the apartment
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Problem: a cashier might pocket cash and not ring in the
sale
- the key feature of an illegitimate transaction is the lack
of a receipt
- a simple sign giving customers an incentive to alert
management if they dont get a receipt solves the
problem
- knowing this, the cashier probably wont steal the
money
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Problem: people with insurance are not as careful
with their belongings
- the main reason is because the individual doesnt
bear the full consequence if something happens
- insurance companies require to you pay a deductible
if you file a claim
- because you are responsible for part of the bill, you
are more likely to be conscientious in your filing of
claims
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Signaling vs Screening
Signaling is an action that the informedparty undertakesin the attempt of conveying information to an uninformed
party.
- advertising
- your resume
- clothes you wear
Screening is an action that the uniformedparty undertakes
in the attempt of learning more about the informed party.
- undergo a physical before you can buy life
insurance
- job ad lists a college degree as a qualification
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Summary:
Imbalanced information can cause problems.
Hidden actions and hidden characteristics are two
types of information asymmetry.
Signaling and screening are two ways that parties try
to solve information asymmetry issues.
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What did you learn today?
Please explain 2 concepts from todays class.