Managerial Economics Lecture Twelve Winter 2013
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Transcript of Managerial Economics Lecture Twelve Winter 2013
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ASYMMETRIC INFORMATION Managerial Economics
Jack Wu
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NTUC INCOME: PREMIUMS FOR $200,000 LIFE INSURANCE
female male
civil servant group policy• maximum coverage limit• no medical exam
$240 $240
individual policy• no maximum coverage• medical exam required
$991 $1849
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IMPERFECT/ASYMMETRIC INFORMATION
imperfect information – absence of certainknowledge (uncertainty)
asymmetric information -- one party has better information than the other
party with worse information also suffers from imperfectinformation
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RISK
uncertainty about benefit or cost
arises from imperfect information
risk-averse person prefers certain payment to
uncertain payments with same expected value risk-averse person will buy insurance
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0
2
3
5
7
8
1 2 3 8
supply of good vintage
combined supply of good and bad vintage
actual demand(marginal benefit)
demand (marginal benefit)for good vintage
Quantity (Thousand cases a month)
P r i c e
( H u n d r e d
$ p
e r c a s e )
WINE MARKET EQUILIBRIUM, I
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WINE MARKET EQUILIBRIUM, II
actual demand = combined supply of good and bad
at equilibrium price
actual marginal benefit (adjusted for prob of getting badvintage) = price
actual marginal cost (of good vintage) = price
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ADVERSE SELECTION
economic inefficiency
possible market failure
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0
2
8
F 8
c
d
combined supply of goodand bad vintages
actual demand(marginal benefit)
demand (marginal benefit)for good vintage
Quantity (Thousand cases a month)
P r i c e
( H u n d r e d
$
p e r c a s e )
MARKET FAILURE, I
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M ARKET F AILURE, II
conventional market: when supply exceeds demand,lower price restores equilibrium
wine market with adverse selection: lower pricedrives out better vintages, leaving even worseadverse selection
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LIFE INSURANCE, I
Coverage = $200,000 for 43 year-old male
NTUC Income
Singapore
Pacific Century
Hong Kong
Group policy $240 $212
Individual (non-
smoker)
$1849 $466
Individual (smoker) $1849 $1120
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LIFE INSURANCE, II
group policy avoids adverse selection
individual policy attracts adverse selection
no maximum policy coverage
medical examination required
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APPRAISAL
characteristic is objectively verifiable
potential gain covers appraisal cost
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• less informed party indirectly elicitsother party’s characteristic through
structured choice• better informed party must be
differentially sensitive to the choice
SCREENING
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WHO’ S THE REAL MOTHER?
Solomon: “Divide the living child into two, and give halfto the one, and half to the other.”
Woman whose son was alive: “give her the living child,and by no means slay it.”
Other woman: “It shall be neither mine nor yours; divideit.”
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INDIRECT SEGMENT DISCRIMINATION
restricted vis-a-vis unrestricted air fares
separate cable channels vis-à-vis bundle
cents-off coupons
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MULTIPLE ASYMMETRIES
screening mechanisms may conflict
example -- auto insurance policy: higher deductible
screens out bad drivers
screens out more risk-averse
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AUCTION
auctions to sell: seller doesn’ t know buyers’ valuations
auctions to buy: buyer doesn’ t know sellers’ costs
use competitive pressure to force bidders toreveal their information
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AUCTION METHODS
open/sealed bidding
discriminatory/non-discriminatory pricing
reserve price
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WINNER’ S CURSE
In auction to buy: winning bidder over-estimates thetrue value
In auction to sell: winning bidder under-estimatesthe true cost
More severe where more bidders
true value/cost more uncertain
sealed-bid auction
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• better informed party communicatescharacteristic through signal
• cost of signal differs according tocharacteristic self-selection signalis credible
SIGNALING
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SIGNALING: EXAMPLES
auto manufacturers – extended warranty
Intuit – money-back guarantee on Quicken
U.S. publicly-listed companies -- dividends
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ADVERTISING AS A SIGNAL
advertising expenditure must be sunk
buyers must be able to detect poor quality
information about poor quality must quickly spread
and cut into seller ’ s future business
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CONTINGENT CONTRACT
Payment is contingent on realized characteristic:
international trade -- buyback (supplier of technologymust buy future product)
mergers and acquisitions – payment in shares
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CONTINGENT FEE
Lawyer has better information about likelihood ofsuccess at trial
contingent fee
time-based fee
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DISCUSSION
This question applies the technique for deriving a marketequilibrium with adverse selection presented in the mathsupplement. Suppose that the demand for genuine antiquesis D = 4 - p, and the supply is S = p - 2, where D and S are inthousands of units a month, and p represents price inhundreds of dollars. In addition, some sellers produce 500
fakes at zero marginal cost.
In a market of purely genuine antiques, what will be (i) thebuyers' marginal benefit from a quantity Q, (ii) the sellers'marginal cost of providing a quantity Q, (iii) the marketequilibrium price and quantity.
In a market including both genuine antiques and fakes,what will be (i) the buyers' marginal benefit from a quantityQ, (ii) the sellers' marginal cost of providing a quantity Q,(iii) the market equilibrium price and quantity.