Chapter 22 Frontiers of Microeconomics Asymmetric Information Information asymmetry one person knows more about what is going on than the other a difference in access to relevant knowledge Hidden action a worker knows more than his employer about how much effort he puts into his job o Moral hazard the tendency of a person who is imperfectly monitored to engage in dishonest or otherwise undesirable behavior is the temptation of imperfectly monitored workers to shirk their responsibilities o Agent a person who is performing an act for another person called the principal worker o Principal a person for whom another person called the agent is performing some act employer o Employers can respond to this problem by monitoring better giving high wages or delayed payment Hidden characteristic a seller of a used car knows more than the buyer about the car s condition o Adverse selection the tendency for the mix of unobserved attributes to become undesirable from the standpoint of an uniformed party a problem that arises in markets in which the seller knows more about the attributes of the good being sold than the buyer does o Buyers are apprehensive about getting a lemon o Another example labor market when a firm cuts wages talented workers are more likely to quit a firm may choose to pay an above equilibrium wage to attract better workers o Another example insurance buyers of health insurance know more about their own health problems than do insurance companies o When markets suffer from adverse selection the invisible hand does not necessarily work its magic Ways markets can respond to asymmetric information o Signaling an action taken by an informed party to reveal private information to an uninformed party A firm may spend money on advertising to signal to potential customers that they have high quality products Students may earn college degrees to signal to potential employers that they are high ability individuals Signal must be costly but be less costly more beneficial to the person with the higher quality product o Screening an action taken by an uninformed party to induce an informed party to reveal information Ex a person buying a used car asks that it be checked by an auto mechanic before the sale The study of asymmetric information gives us a new reason to be wary of markets asymmetric information may call for government action in some cases but 3 facts complicate the issue o 1 The private market can sometimes deal with information asymmetries on its own using a combination of signaling and screening o 2 The government rarely has more information than the private parties o 3 The government itself is an imperfect institution Behavior Economics Behavioral economics the subfield of economics that integrates the People do not always think rationally viewed not as rational maximizers but insights of psychology as satisficers only near rational People are overconfident give too much weight to a small number of vivid observations and are reluctant to change their minds People are driven by some innate force of fairness People are inconsistent over time o The desire for instant gratification induces the decision maker to abandon his past plans
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