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Level 22

Asymmetric Information: Adverse Selection & Moral


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Asymmetric Information
situation when one party doesn't know enough about the other party to make accurate decisions. This creates two kinds of problems:
mixed market
a market in which goods of different qualities are sold for the same price
adverse- selection problem
a situation in which the uninformed side of the market must choose from an undesirable or adverse selection of goods
thin market
a market in which some high-quality goods are sold but fewer than would be sold in a market with perfect information
experience rating
a situation in which insurance companies charge different prices for medical insurance to different firms depending on the past medical bills of the firms employees
moral hazard
a situation in which one side of an economic relationship takes an undesirable or costly action that the other side of the relationship cannot observe
discovered price
the lowest price observed so far in a search process
reservation price
the price at which a consumer is indifferent about additional search for a lower price
Car example
Car seller has better information than the buyer
Lemon
bad used car
Plum
good used car
Determine a consumer's willingness to pay in a mixed market
how much is the consumer willing to pay for a plum? lemon? what is the chance that it will turn out to be a lemon?
with price
the number of lemons supplied increases
plums supplied
the higher the price of used cars, the larger the number of
50/50 expectations
not realistic/not equilibruim
adverse-selection problem
the uninformed side of the market must choose from an undesirable or adverse selection of goods. (due to the asymmetrical information. Mixture of cars offered to buy are not the best. Don not get …
To overcome lemons problems
buyers can request information
money-back guarentees
seller promises a refund if the car turns out to be a lemon.
warranties and repair guarentees
seller promises to cover any extraordinary repair costs for a year.
Lemon Law
dealers are required to repurchase vehicles that have been brought back for repair at least 30 days after purchase
lemons law buyback
car must be labeled as lemon.
insurance
buyer knows more than seller
insurance demand
downward sloping
the presence of high-cost consumers in the market (insurance)
pulls up the average cost of service, pulling up the price
decreases
the increase in price _______the number of low-cost consumers who purchase insurance
pulls up the average cost of insurance
the decrease in the number of low-cost consumers
still exists
Adverse selection _______in insurance
to prevent moral hazard
insurance companies provide ductibles
moral hazard problem
tendency of one party to a contract or agreement to alter his/her behavior, after the contract is signed
adverse selection problem
A problem arising when information known to one party to a contract or agreement is not known to the other party, causing the latter to incur major costs. Example: Individuals who have the poorest he…
public choice theory
the economic analysis of government decision making, politics, and elections.
logrolling
trading of votes to secure desired outcomes
paradox of voting
a situation in which society may not be able to rank its preferences consistently through paired-choice majority voting
median-voter model
under majority rule and consistent voting preferences, the median voter will in a sense determine the outcomes of elections
government failure
economically inefficient outcomes caused by shortcomings in the public sector
principal agent problems
conflicts that arise when tasks are delegated by one group of ppl (principals) to another group of ppl (agents)
collective action problem
Problems that are associated with people benefiting from the labors or efforts of others. People will often choose not to contribute to a cause if they believe they will benefit anyway
special-interest effect
any outcome of the political process whereby a small number of people obtain a government program or policy that gives them large gains at the expense of a much greater number of persons who individually suffer small losses
earmarks
Hidden congressional provisions that direct the federal government to fund specific projects or that exempt specific persons or groups from paying specific federal taxes or fees
rent seeking
appeal to govt for special benefits at someone else's expense
political corruption
unlawful misdirection of govt resources, actions when govt officials abuse power
Principal
the amount of money borrowed in a loan of the amount of your money in savings account that is earning interest
agent
a person or firm who is supposed to act on behalf of the principal
incentive compatible
debt contract aligns the incentives of the borrower with those of the lender
Gross Consumer Surplus
The most consumers would pay for a bundle rather than doing without it
Common Values Setting
Object has the same value to all bidders, but each only has an imprecise estimate of it's value
winner's curse
the plight of the winning bidder who overestimates an asset's true value
signaling
using a proxy measure to communicate information about unobservable characteristics
Separating Equilibrium
Each type chooses a different action in a signaling game
Pooling Equilibrium
All types choose the same action in a signaling game