intro to economics - information

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.

intro to economics - information

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