CALTECH EC 106 - Lecture notes (15 pages)

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Lecture notes



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Lecture notes

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Pages:
15
School:
California Institute of Technology
Course:
Ec 106 - Topics In Applied Industrial Organization

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Imperfect information Up to now consider only firms and consumers who are perfectly informed about market conditions 1 prices range of products available 2 characteristics or relative qualities of available products 3 consumers preferences demand functions Specific models where firms and or consumers have imperfect information How is imperfect information resolved How does imperfect information affect firm behavior pricing advertising 1 Adverse selection lemons used car markets 2 Moral hazard insurance markets 3 Price uncertainty search markets Two important types of imperfect information Adverse selection individuals have different but unobserved types Hidden information 1 Used cars only seller knows true quality of car 2 Similar in spirit to 2 degree price discrimination airline pricing Moral hazard individuals can take unobserved actions which affect market outcome Hidden action 1 Insurance markets insured people may not take necessary precautions raises the avg payment of insurance company and therefore average premium 2 Labor markets when employees work in teams where individual effort not observable each employee has incentive to free ride These markets characterized by asymmetric information firms and consumers are differentially informed Adverse selection information is asymmetric when transactions are made Moral hazard information becomes asymmetric after transactions are made Additional examples Adverse selection 1 Example the used car market Two types of used cars good and bad providing utility of u G and uB Proportion p are bad In competitive market with perfect information pb uB pG uG Consider asymmetric information only seller knows car type buyer doesn t know Average used car in the market yields expected utility u 1 p uG p uB Buyer is willing to offer u for any given car by doing so break even on average At u only owners of bad cars willing to sell since ub u Owners of good cars stay out of market since uG u Outcome buyer offers uB and only bad cars



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