Markets with Asymmetric Information
اسلاید 1: Chapter 17Markets with Asymmetric Information
اسلاید 2: Chapter 17Slide 2Topics to be DiscussedQuality Uncertainty and the Market for LemonsMarket SignalingMoral HazardThe Principal-Agent Problem
اسلاید 3: Chapter 17Slide 3Topics to be DiscussedManagerial Incentives in an Integrated FirmAsymmetric Information in Labor Markets: Efficiency Wage Theory
اسلاید 4: Chapter 17Slide 4IntroductionWe will study how imperfect information influences resource allocation and the price system.
اسلاید 5: Chapter 17Slide 5Quality Uncertainty and the Market for LemonsThe lack of complete information when purchasing a used car increases the risk of the purchase and lowers the value of the car.
اسلاید 6: Chapter 17Slide 6The Market for Used CarsAssumeBuyers and sellers can distinguish between high and low quality carsThere will be two marketsQuality Uncertainty and the Market for Lemons
اسلاید 7: The Lemons ProblemPHPLQHQLSHSLDHDL5,00050,00050,000The market for high and lowquality cars when buyers and sellerscan identify each car10,000DLDMDM75,00025,000With asymmetric information buyers will find it difficult to determine quality. They lower their expectations of the average quality ofused cars. Demand for low and high quality used cars shifts to DM.DLMDLMThe increase in QLreduces expectations anddemand to DLM. The adjustment processcontinues until demand = DL.
اسلاید 8: Chapter 17Slide 8The Market for Used CarsWith asymmetric information:Low quality goods drive high quality goods out of the market.The market has failed to produce mutually beneficial trade.Too many low and too few high quality cars are on the market.Adverse selection occurs; the only cars on the market will be low quality cars.Quality Uncertainty and the Market for Lemons
اسلاید 9: Chapter 17Slide 9Implications of Asymmetric InformationMedical InsuranceQuestionIs it possible for insurance companies to separate high and low risk policy holders?If not, only high risk people will purchase insurance.Adverse selection would make medical insurance unprofitable.The Market for Insurance
اسلاید 10: Chapter 17Slide 10Implications of Asymmetric InformationAutomobile InsuranceQuestionsWhat impact does asymmetric information and adverse selection have on insurance rates and the delivery of automobile accident insurance?How can the government reduce the impact of adverse selection in the insurance industry?The Market for Insurance
اسلاید 11: Chapter 17Slide 11Implications of Asymmetric InformationThe Market for CreditAsymmetric information creates the potential that only high risk borrowers will seek loans.QuestionHow can credit histories help make this market more efficient and reduce the cost of credit?
اسلاید 12: Chapter 17Slide 12Implications of Asymmetric InformationThe Importance of Reputation and StandardizationAsymmetric Information and Daily Market DecisionsRetail salesAntiques, art, rare coinsHome repairsRestaurants
اسلاید 13: Chapter 17Slide 13Implications of Asymmetric InformationQuestionHow can these producers provide high-quality goods when asymmetric information will drive out high-quality goods through adverse selection.AnswerReputation
اسلاید 14: Chapter 17Slide 14Implications of Asymmetric InformationQuestionWhy do you look forward to a Big Mac when traveling even though you would never consider buying one at home.Holiday Inn once advertised “No Surprises” to address the issue of adverse selection.
اسلاید 15: Chapter 17Slide 15Lemons in Major League BaseballAsymmetric information and the market for free agentsIf a lemons market exists, free agents should be less reliable (disabled) than renewed contracts.
اسلاید 16: Chapter 17Slide 16Player DisabilityAll Players4.7312.55165.4Renewed players4.769.68103.4Free agents4.6717.23268.9Days Spent on Disabled List per SeasonPrecontractPostcontractPercentage Change
اسلاید 17: Chapter 17Slide 17FindingsDays on the disabled list increase for both free agents and renewed players.Free agents have a significantly higher disability rate than renewed players.This indicates a lemons market.Lemons in Major League Baseball
اسلاید 18: Chapter 17Slide 18QuestionIf you are a team owner, what steps would you take to reduce the asymmetric information for free agents?Lemons in Major League Baseball
اسلاید 19: Chapter 17Slide 19Market SignalingThe process of sellers using signals to convey information to buyers about the product’s quality helps buyers and sellers deal with asymmetric information.
اسلاید 20: Chapter 17Slide 20Market SignalingStrong SignalTo be effective, a signal must be easier for high quality sellers to give than low quality sellers.ExampleHighly productive workers signal with educational attainment level.
اسلاید 21: Chapter 17Slide 21Market SignalingA Simple Model of Job Market SignalingAssumeTwo groups of workersGroup I: Low productivity--AP & MP = 1Group II: High productivity--AP & MP = 2The workers are equally divided between Group I and Group II--AP for all workers = 1.5
اسلاید 22: Chapter 17Slide 22Market SignalingA Simple Model of Job Market SignalingAssumeCompetitive Product MarketP = $10,000Employees average 10 years of employmentGroup I Revenue = $100,000 (10,000/yr. x 10)Group II Revenue = $200,000 (20,000/yr. X 10)
اسلاید 23: Chapter 17Slide 23Market SignalingWith Complete Informationw = MRPGroup I wage = $10,000/yr.Group II wage = $20,000/yr.With Asymmetric Informationw = average productivityGroup I & II wage = $15,000
اسلاید 24: Chapter 17Slide 24Market SignalingSignaling With Education to Reduce Asymmetric Informationy = education index (years of higher education)C = cost of attaining educational level yGroup I--CI(y) = $40,000yGroup II--CII(y) = $20,000y
اسلاید 25: Chapter 17Slide 25Market SignalingSignaling With Education to Reduce Asymmetric InformationAssume education does not increase productivityDecision Rule:y* signals GII and wage = $20,000Below y* signals GI and wage = $10,000
اسلاید 26: SignalingYears ofCollegeValue ofCollegeEduc.0$100KValue ofCollegeEduc.Years ofCollege1234560123456$200K$100K$200KGroup IGroup IICI(y) = $40,000yOptimal choice of y for Group IHow much educationshould a person obtain?The education decisionis based on benefits/costcomparison.B(y)B(y)y*y*B(y) = increase inwage associated witheach level of educationCII(y) = $20,000yOptimal choice of y for Group I
اسلاید 27: SignalingYears ofCollegeValue ofCollegeEduc.0$100KValue ofCollegeEduc.Years ofCollege1234560123456$200K$100K$200KCI(y) = $40,000yOptimal choice of y for Group IB(y)B(y)y*y*Benefits = $100,000CostCI(y) = 40,000y$100,000<$40,000y*y* > 2.5Choose no educationCII(y) = $20,000yOptimal choice of y for Group IBenefits = $100,000CostCII(yO)= 20,000y$100,000<$20,000y*y* < 5Choose y*
اسلاید 28: Chapter 17Slide 28SignalingCost/Benefit ComparisonDecision rule works if y* is between 2.5 and 5If y* = 4Group I would choose no schoolGroup II would choose y*Rule discriminates correctly
اسلاید 29: Chapter 17Slide 29SignalingEducation does increase productivity and provides a useful signal about individual work habits.
اسلاید 30: Chapter 17Slide 30Working into the NightQuestionHow can you signal to your employer you are more productive?
اسلاید 31: Chapter 17Slide 31Market SignalingGuarantees and WarrantiesSignaling to identify high quality and dependabilityEffective decision tool because the cost of warranties to low-quality producers is too high
اسلاید 32: Chapter 17Slide 32Moral HazardMoral hazard occurs when the insured party whose actions are unobserved can affect the probability or magnitude of a payment associated with an event.
اسلاید 33: Chapter 17Slide 33Moral HazardDetermining the Premium for Fire InsuranceWarehouse worth $100,000Probability of a fire:.005 with a $50 fire prevention program.01 without the program
اسلاید 34: Chapter 17Slide 34Moral HazardDetermining the Premium for Fire InsuranceWith the program the premium is:.005 x $100,000 = $500Once insured owners purchase the insurance, the owners no longer have an incentive to run the program, therefore the probability of loss is .01$500 premium will lead to a loss because the expected loss is not $1,000 (.01 x $100,000)
اسلاید 35: Chapter 17Slide 35The Effects of Moral HazardMiles per Week0$0.5050100140CostperMile$1.00$1.50$2.00D = MBMC’With moral hazard insurance companies cannot measure mileage. MC to $1.00 andmiles driven increases to 140miles/week--inefficient allocation.MCMC is the marginal costof driving. With no moral hazard and assuming insurance companies can measure milesdriven MC = MB at $1.50 and100 miles/week--efficient allocation.
اسلاید 36: Chapter 17Slide 36Reducing Moral Hazard --Warranties of Animal HealthScenarioLivestock buyers want disease free animals.Asymmetric information existsMany states require warrantiesBuyers and sellers no longer have an incentive to reduce disease (moral hazard).QuestionHow can this moral hazard be reduced?
اسلاید 37: Chapter 17Slide 37Crisis in the Savings and Loan IndustryQuestionHow many people know the financial strength of their bank?Why not?Deposit insurance, moral hazard, and failures in the S&L industry
اسلاید 38: Chapter 17Slide 38Cost of the S&L Bailout1,000+ failed institutions$200 billion (1990)Texas alone--$42 billion (1990)Agency expenditures--$100 million (1990)QuestionHow can this moral hazard be reduced?Crisis in the Savings and Loan Industry
اسلاید 39: Chapter 17Slide 39The Principal--Agent ProblemAgency Relationship One person’s welfare depends on what another person doesAgentPerson who actsPrincipalPerson whom the action effects
اسلاید 40: Chapter 17Slide 40The Principal--Agent ProblemCompany owners are principals.Workers and managers are agents.Owners do not have complete knowledge.Employees may pursue their own goals and reduce profits.
اسلاید 41: Chapter 17Slide 41The Principal--Agent ProblemThe Principal--Agent Problem in Private EnterprisesOnly 16 of 100 largest corporations have individual family or financial institution ownership exceeding 10%.Most large firms are controlled by management.Monitoring management is costly (asymmetric information).
اسلاید 42: Chapter 17Slide 42The Principal--Agent ProblemThe Principal--Agent Problem in Private EnterprisesManagers may pursue their own objectives.GrowthUtility from job
اسلاید 43: Chapter 17Slide 43The Principal--Agent ProblemThe Principal--Agent Problem in Private EnterprisesLimitations to managers’ ability to deviate from objective of ownersStockholders can oust managersTakeover attemptsMarket for managers who maximize profits
اسلاید 44: Chapter 17Slide 44The Principal--Agent ProblemThe Principal--Agent Problem in Public EnterprisesObservationsManagers’ goals may deviate from the agencies goal (size)Oversight is difficult (asymmetric information)Market forces are lacking
اسلاید 45: Chapter 17Slide 45The Principal--Agent ProblemThe Principal--Agent Problem in Public EnterprisesLimitations to Management PowerManagers choose a public service positionManagerial job marketLegislative and agency oversight (GAO & OMB)Competition among agencies
اسلاید 46: Chapter 17Slide 46The Managers of Nonprofit Hospitals as AgentsAre non profit organizations more or less efficient that for-profit firms?725 hospitals from 14 hospital chainsReturn on investment (ROI) and average cost (AC) measured
اسلاید 47: Chapter 17Slide 47For-Profit11.6%12.7%Nonprofit8.8%7.4%Return On Investment19771981The Managers of Nonprofit Hospitals as Agents
اسلاید 48: Chapter 17Slide 48After adjusting for differences in services:AC/patient day in nonprofits is 8% greater than profitsConclusionProfit incentive impacts performanceCost and benefits of subsidizing nonprofits must be considered.The Managers of Nonprofit Hospitals as Agents
اسلاید 49: Chapter 17Slide 49Incentives in the Principal-Agent FrameworkDesigning a reward system to align the principal and agent’s goals--an exampleWatch manufacturerUses labor and machineryOwners goal is to maximize profitMachine repairperson can influence reliability of machines and profitsThe Managers of Nonprofit Hospitals as Agents
اسلاید 50: Chapter 17Slide 50The Principal--Agent ProblemIncentives in the Principal-Agent FrameworkDesigning a reward system to align the principal and agent’s goals--an exampleRevenue also depends, in part, on the quality of parts and the reliability of labor.High monitoring cost makes it difficult to assess the repair-person’s work
اسلاید 51: Chapter 17Slide 51The Revenue from Making WatchesLow effort (a = 0)$10,000$20,000High effort (a = 1)$20,000$40,000Poor LuckGood Luck
اسلاید 52: Chapter 17Slide 52The Principal--Agent ProblemIncentives in the Principal-Agent FrameworkDesigning a reward system to align the principal and agent’s goals--an exampleRepairperson can work with either high or low effortRevenues depend on effort relative to the other events (poor or good luck)Owners cannot determine a high or low effort when revenue = $20,000
اسلاید 53: Chapter 17Slide 53The Principal--Agent ProblemIncentives in the Principal-Agent FrameworkDesigning a reward system to align the principal and agent’s goals--an exampleRepairperson’s goal is to maximize wage net of costCost = 0 for low effortCost = $10,000 for high effortw(R) = repairperson wage based only on output
اسلاید 54: Chapter 17Slide 54The Principal--Agent ProblemIncentives in the Principal-Agent FrameworkChoosing a Wagew = 0; a = 0; R = $15,000R = $10,000 or $20,000, w = 0R = $40,000; w = $24,000R = $30,000; Profit = $18,000Net wage = $2,000
اسلاید 55: Chapter 17Slide 55The Principal--Agent ProblemIncentives in the Principal-Agent FrameworkChoosing a Wagew = R - $18,000Net wage = $2,000High effort
اسلاید 56: Chapter 17Slide 56The Principal--Agent ProblemConclusionIncentive structure that rewards the outcome of high levels of effort can induce agents to aim for the goals set by the principals.
اسلاید 57: Chapter 17Slide 57The Principal--Agent ProblemAsymmetric Information and Incentive Design in the Integrated FirmIn integrated firms, division managers have better (asymmetric) information about production than central management
اسلاید 58: Chapter 17Slide 58The Principal--Agent ProblemAsymmetric Information and Incentive Design in the Integrated FirmTwo IssuesHow can central management illicit accurate informationHow can central management achieve efficient divisional production
اسلاید 59: Chapter 17Slide 59The Principal--Agent ProblemPossible Incentive PlansBonus based on output or profitWill this plan provide an incentive for accurate information?
اسلاید 60: Chapter 17Slide 60The Principal--Agent ProblemPossible Incentive PlansBonus based on how close the managers get to their forecasts of output and profitsQf = estimate of feasible production levelB = bonus in dollarsQ = actual outputB = 10,000 - .5(Qf - Q)Incentive to underestimate Qf
اسلاید 61: Chapter 17Slide 61The Principal--Agent ProblemPossible Incentive PlansBonus still tied to accuracy of forecastIf Q > Qf ;B = .3Qf + .2(Q - Qf)If Q < Qf ;B = .3Qf - .5(Qf - Q)
اسلاید 62: Chapter 17Slide 62Incentive Design in an Integrated FirmOutput(units per year)2,0004,0006,00010,000010,00020,00030,00040,000Bonus($ peryear)8,000If Qf = 30,000,bonus is $6,000,the maximumamount possible.Qf = 30,000Qf = 10,000If Qf = 10,000,bonus is $5,000Qf = 20,000If Qf = 20,000,bonus is $4,000
اسلاید 63: Chapter 17Slide 63Asymmetric Information in Labor Markets: Efficiency Wage TheoryIn a competitive labor market, all who wish to work will find jobs for a wage equal to their marginal product.However, most countries’ economies experience unemployment.
اسلاید 64: Chapter 17Slide 64The efficiency wage theory can explain the presence of unemployment and wage discrimination.In developing countries, productivity depends on the wage rate for nutritional reasons.Asymmetric Information in Labor Markets: Efficiency Wage Theory
اسلاید 65: Chapter 17Slide 65The shirking model can be better used to explain unemployment and wage discrimination in the United States.Assumes perfectly competitive marketsHowever, workers can work or shirk.Since performance information is limited, workers may not get fired.Asymmetric Information in Labor Markets: Efficiency Wage Theory
اسلاید 66: Chapter 17Slide 66Without shirking, the market wageis w*, and full-employment exists at L*Demand forLaborw*L*SLUnemployment in a Shirking ModelQuantity of LaborWageNo-ShirkingConstraintThe no-shirkingconstraint givesthe wage necessaryto keep workers from shirking.weLeAt the equilibrium wage, We the firm hires Le workerscreating unemployment of L* - Le.
اسلاید 67: Chapter 17Slide 67Efficiency Wages at Ford Motor CompanyLabor turnover at Ford 1913: 380%1914: 1000%Average pay = $2 - $3Ford increased pay to $5
اسلاید 68: Chapter 17Slide 68Efficiency Wages at Ford Motor CompanyResultsProductivity increased 51%Absenteeism had been halvedProfitability rose from $30 million in 1914 to $60 million in 1916.
اسلاید 69: Chapter 17Slide 69SummaryAsymmetric information creates a market failure in which bad products tend to drive good products out of the market.Insurance markets frequently involve asymmetric information because the insuring party has better information about the risk involved than the insurance company.
اسلاید 70: Chapter 17Slide 70SummaryAsymmetric information may make it costly for the owners of firms to monitor accurately the behavior of the firm’s manager.Asymmetric information can explain why labor markets have substantial unemployment when some workers are actively seeking work.
اسلاید 71: End of Chapter 17Markets with Asymmetric Informatio
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