1 Akerlof Asymetrical Information The theory of markets relates to quality and uncertainty In many markets buyers use some market statistic to judge the quality of prospective purchases In this case there is an incentive for sellers to market poor quality merchandise since the returns for good quality accrue mainly to the entire group whose statist is affected rather than to the individual seller In the market for lemons there are the bad products the lemons which may or not be traded The bad products tend to drive out the good in much the same way that bad money drives out the good This is because the bad products drive out the good because they sell at the same price as the good products In Gresham s law presumably both buyer and seller can tell the difference between good and bad money Adverse Selection The principle of adverse selection is potentially present in all lines of insurance There is potential adverse selection in the fact that healthy term insurance policy holders may decide to terminate their coverage when they become older and premiums mount This action could leave an insurer with an undue proportion of below average risks and claims that might be higher than anticipated Adverse selection appears or at least is possible whenever the individual or group insured has freedom to buy or not to buy to choose the amount or plan of insurance and to persist or to discontinue as policyholder Signaling Employers may refuse to hire members of minority groups for certain types of jobs This decision may not reflect irrationality or prejudice but profit maximization For race may serve as a good statistic for the applicant s social background quality of schooling and general job capabilities The Lemons model can be used to make some comments on the cost of dishonesty the purchaser burdens the problem of identifying quality The presence of people who wish to pawn bad wares as good wares tends to drive out the legitimate business The cost of dishonesty therefore therefore it lies not only in the amount by which the purchaser is cheated the cost also must include the loss incurred from driving legitimate business out of existence Dishonesty and quality variation are particularly problematic in underdeveloped countries Institutions that arise to counteract the effects of quality uncertainty are guarantees brand names chains and licensing practices Businesses will suffer where there are indefinite guarantees as generalized by Gresham s law 2 Wheelan Asymmetry Information What we don t know can hurt us Economists study how we acquire information what we do with it ad how we make decisions when we don t have adequate information Statistical discrimination or so called rational discrimination takes place when an individual make an inference that is defensible based on broad statistical patterns but is likely to be wrong in the specific case at hand and has a discriminatory effect on some group It is about information which lies at the heart of many discrimination related problems Information matters particularly when we have all that we need Markets tend to favor the party that knows more But if the imbalance or symmetry of information becomes too large then markets can break down entirely Health care for example is plagued with information problems Consumers of health care the patients almost always have less information about their care than their doctors do This asymmetry of information is at the heart of our health care woes Information makes health care different from the rest of the economy The fundamental challenge of health care reform is paying for the right treatment the product that makes the most sense relative to what it costs Firms use deductibles to screen customers in the insurance business Moral Hazard The lack of incentive to take care of yourself or your property due to the comfort of insurance safety is called moral hazard If the amount of care is observable there is not a problem but in reality insurance companies can t observe all the relevant actions of those they insure This is why most insurance policies include a deductible an amount that the insured party hast o pay in any claim By making the consumers pay part of a claim the insurance companies can make sure that the consumer always has an incentive to take some amount of care In the case of moral hazard a market equilibrium has the property that each consumer would like to buy more insurance and the insurance companies would be willing to provide more insurance if the consumers continued to take the same about of care but this trade wouldn t happen because if the consumers were able to purchase more insurance they would rationally choose to take less care Moral hazard refers to situations where one side of the market cant observe the actions of the other For this reason it is sometimes called a hidden action problem Adverse selection refers to situations where one side of the market cant observe the type or quality of the goods on the other side of the market For this reason it is sometimes called a hidden information problem Signaling Screening Sellers chose actions that signal the quality of their products this makes the market perform better i e a warranty 3 Varian 4 McCubbins Sheepskin effect particular signals such as having a college diploma relay positive signals regarding your work ethic and such to consumers bosses Signaling refers to the fact that when adverse selection or moral hazard are present some agents will want to invest in signals that will differentiate them from other agents Investment in signals may be privately beneficial but publically wasteful On the other hand investment in signals may help to solve problems due to asymmetric information Efficient incentive schemes leave the worker as the residual claimant This means that the worker will equate marginal benefits and marginal costs Administrative Procedures in Political Control A central problem of representative democracy is how to ensure that policy decisions are responsive to the interests or preferences of citizens Elected officials delegate considerable policymaking authority to unelected bureaucrats Because elected officials have limited resources for monitoring agency performance the possibility arises that bureaucrats will not comply with their policy preferences This gives rise to the question how or indeed whether elected political officials can reasonably effectively assure that their policy intentions will be carried