APPLIED ECONOMICS FOR MANAGERS SESSION 16 I REVIEW INFORMATION AND MARKET EFFICIENCY A THE CONUNDRUM OF INFORMATIONAL EFFICIENCY 1 EFFICIENCY REQUIRES THAT CURRENT PRICES REFLECT INFORMATION AS SOON AS IT IS KNOWN a INFORMATION ABOUT ASSET FUTURE INCOME RISK b INFORMATION ABOUT GOODS AND SERVICES QUALITY 2 MARKETS MAY BE INFORMATIONALLY EFFICIENT BECAUSE IT S HARD TO EXCLUDE THOSE WHO DON T PAY 3 IN ANY CASE WE WAN T EFFICIENT MARKETS SINCE INFORMATION IS NON RIVALROUS IN CONSUMPTION 4 MARKETS TEND TO UNDERPRODUCE PUBLIC GOODS B POSSIBLE EXAMPLES 1 RETAIL SERVICES 2 FINANCIAL ECONOMIC DATA 3 NEW MEDICINES C POSSIBLE SOLUTIONS TO INFORMATION SUPPLY PROBLEM 1 PATENTS COPYRIGHTS TEMPORARY MONOPOLY 2 SUBSIDIZE PRODUCTION PUBLIC RESEARCH FUNDS 3 LIVE WITH IT II ASYMMETRIC INFORMATION A SOMETIMES AGENTS CAN KEEP INFORMATION PRIVATE CAN THEY EXPLOIT IT THEN HOW IMPLICATIONS B BACKGROUND RISK AVERSION INSURANCE MARKETS 1 CONSIDER EARLIER EXAMPLE WITH WEALTH 300 000 BUT A 10 CHANCE THAT IT WILL FALL IN VALUE TO 60 000 2 INSURANCE DEMAND a POSSIBLE LOSS 240 000 WITH PROBABILITY PL 0 1 b WOULD PAY 40 000 TO AVOID RISK CERTAIN 260 000 U X E U X 60 000 260 000 300 000 INCOME 276 000 3 INSURANCE SUPPLY COMPETITION NO PROFIT a WITH PROBABILITY 0 1 INDEMNIFY THE LOSS OF 240 000 b ACTUARIALLY FAIR PREMIUM 24 000 B ANOTHER PAPER CLIP MARKET C INFORMATIONAL ASYMMETRIES AND 1 ADVERSE SELECTION 2 MORAL HAZARD D ASYMMETRIC INFORMATION 1 THE WAY TO EXPLOIT INFORMATION IS TO KEEP IT PRIVATE 2 IF INFORMATION IS ASYMMETRIC ONE PARTY TO THE BARGAIN KNOWS IT IS DISADVANTAGED UNINFORMED III GAMES AND INFORMATION WITHIN AN ORGANIZATION A RULES FOR ORGANIZATIONS 1 CLARIFY THE OBJECTIVE 2 KNOW THE GAME YOU RE PLAYING B FIRM OBJECTIVES 1 CREAT SURPLUS 2 CAPTURE SUPRLUS C THE SURPLUS TREE CUSTOMERS RIVALS COMPLEMENTARY FIRMS FIRM SUPPLIERS D POTENTIAL CONFLICTS THAT MAY HINDER SURPLUS CREATION CAPTURE 1 PRINCIPAL AGENT PROBLEMS a OWNERS VS MANAGERS b MANAGERS VS WORKERS 2 LET PROFIT DEPEND ON MANAGERIAL EFFORT LUCK LUCK BAD P GOOD P MANAGERIAL EFFORT LOW 0 30 000 60 000 HIGH 1 60 000 120 000 a CLASSIC PROBLEM IF PROFIT IS 60 000 CANNOT BE SURE IF IT IS DUE TO LOW EFFORT OR TO BAD LUCK b CONTRACT MUST SOLVE TWO PROBLEMS i INCENTIVE CONSTRAINT MUST ELICIT HIGH EFFORT FROM MANAGER ii PARTICIPATION CONSTRAINT MANAGER EXPECTS TO COVER OPPORTUNITY COST 3 SUPPOSE a MANAGER CAN EARN 10 000 ELSEWHERE b MANAGER INCURS LOSS OF 10 000 PER UNIT EFFORT 4 TRY BONUS CONTRACT W 0 IF PROFIT 60 000 W 40 000 IF PROFIT 60 000 INCENTIVE COMPATIBILITY EXPECTED WAGE IF EFFORT 1 E W 0 40 000 20 000 EXPECTED WAGE IF EFFORT 0 E W 0 PARTICIPATION EXPECTED WAGE IF EFFORT 1 IS 20 000 JUST COVERS THE COST OF EFFORT PLUS OTHER OPPORTUNITY 5 ALTERNATIVE PROFIT SHARING CONTRACT W 1 4 PROFIT 6 TOURNAMENT E RISK AVERSION AND PERFORMANCE BASED CONTRACTS F CONTRACTUAL RELATIONS AND FIRM SPECIFIC INVESTMENTS TIME CONSISTENCY ISSUES