A situation characterized by inefficient distribution of resources when agents involved have asymmetric information which results from some agents not being able to observe some characteristic of other agents or goods. Under adverse selection both sides of the market suffer economic losses.
A situation characterized by inefficient distribution of resources when agents involved have asymmetric information which results from principal not being able to observe the actions of the agent. Under moral hazard both sides of the principal-agent relationship suffer economic losses: agent because of low wages; principal because of low profits.
Diminishing marginal returns of utility.
Constant marginal return of utility.
Increasing marginal returns of utility.
A highly credible threat. Dr Strangelove's doomsday device.
It is in the firm's best interest to go through with the threat. Burning bridges.
It is not in the firm's best interest to pursue the threat.
Describe the Westinghouse-GE case
A Bertrand Duopoly
Quantities are set simultaneously.
Competition is based on price-setting simultaneously.
Quantities are set by a leader firm, where followers after set their quantities independently.
How does profits differ in different market structures for the total market?
How does profits differ in different market structures for individual firms?
an action taken by an uninformed person to determine the information possessed by informed people
an action taken by an informed person to send information to an uninformed person
What are the responses to adverse selection?
Restrict opportunistic behavior and to equalize information.
unsubstantiated claims or statements
an equilibrium in which dissimilar people are treated (paid) alike or behave alike
an equilibrium in which one type of people takes actions that allow them to be differentiated from other types of people
consumers cannot distinguish between good and bad products before purchase, bad products may drive good ones out of the market. The lemons problem is due to adverse selection
an agreement with provisions that ensures that no party can be made better off without harming the other party
efficiency in production
a situation in which the principal's and agent's combined value is maximised.
efficiency in risk bearing
a situation in which risk sharing is optimal in that the person who least minds facing risk bears more of the risk.
refers to a contract's provision of inducements such that the agent want to perform the assigned task rather than engage in opportunistic behavior.
Types of contracts
fixed fee rental contract
hire contract, per unit pay
contingent contract: share revenue or profit
A payment to a lawyer that is a share of the award in a court case if the client wins and nothing if the client lose.
Monitoring of agents can be done through...
Bonding- agents are required to deposit funds guaranteeing their good behavior.
Deferred payments- serve the same function as bonds.
Efficiency wages- an unusually high wage that firms pay workers as an incentive to avoid shirking.
provides a benefit
Bayesian Nash Equilibrium
For static games with incomplete information
All players have dominant strategies which lead to a profit that is inferior to what they could achieve if they cooperated and pursued alternative strategies.
How do we estimate a probability?
the probability weighted average of the monetary value
the probability weighted average of the utility from the monetary value
a wager with EV=0
Why are there biases in estimating probabilities?
When does risk-preference vary with circumstances?
certainty effect: allais effect
framing- how a problem is formulated. less risk adverse when discussing gains and more adverse when it comes to making losses.
Alternative theory of decision making under uncertainty. Assumes people care about the change in wealth rather than the level of wealth. People start with a reference point, where v=0 and then the curve is S shaped. People treat gains and losses differently.
the cost of production only, externalities are excluded
The private cost + the cost of the harms from externalities.
How are externalities reduced?
Government can put emission standards and fees to internalize the externality.
The optimal level of pollution and output can result from bargaining between polluters and their victims if property rights are clearly defined. Property rights can be assigned to either of two parties, resulting in an efficient outcome if the par ties can bargain.
A commodity or service whose consumption does not preclude others from also consuming it. Lacks rivalry and exclusion.
Market for public goods
Exists only if non purchasers can be excluded from consuming them. Most people are unwilling to pay for their share of a public good- freer riding.
How is free riding reduced?
How are public goods evaluated?
Surveys and votes.
opportunism characterized by an informed person's benefiting from trading or contracting with a less informed person who does not know about an unobserved characteristic of the informed person.
How are lemons limited?
Laws that prevent opportunism
standards & certifications
Signaling by firms
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