Asymmetric Information

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Chapter 37

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Asymmetric Information
Introduction. The economics of information and incentives is a relatively new branch of microeconomics, in which much intriguing work is going on. This chapter shows you a sample of these problems and the way that economists think about them. 37.1 (0) There are two types of electric pencil-sharpener producers. “High-quality” manufacturers produce very good sharpeners that consumers value at $14. “Low-quality” manufacturers produce less good ones that are valued at $8. At the time of purchase, customers cannot distinguish between a high-quality product and a low-quality product; nor can they identify the manufacturer. However, they can determine the quality of the product after purchase. The consumers are risk neutral; if they have probability q of getting a high-quality product and 1 − q of getting a low-quality product, then they value this prospect at 14q + 8(1 − q). Each type of manufacturer can manufacture the product at a constant unit cost of $11.50. All manufacturers behave competitively. (a) Suppose that the sale of low-quality electric pencil-sharpeners is illegal, so that the only items allowed to appear on the market are of high quality. What will be the equilibrium price?

$11.50.

(b) Suppose that there were no high-quality sellers. How many low-quality sharpeners would you expect to be sold in equilibrium?

Sellers

won’t sell for less than $11.50, consumers won’t pay that much for low-quality product. So in equilibrium there would be no sales. (c) Could there be an equilibrium in which equal (positive) quantities of the two types of pencil sharpeners appear in the market?

No.

Average willingness to pay would be $11, which is less than the cost of production. So there would be zero trade.

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ASYMMETRIC INFORMATION

(Ch. 37)

(d) Now we change our assumptions about the technology. Suppose that each producer can choose to manufacture either a high-quality or a low-quality pencil-sharpener, with a unit cost of $11.50 for the former and $11 for the latter, what would we expect to happen in equilibrium?

No trade. Producers would produce the

low-quality product since it has a lower production cost. If all producers produce low-quality output, costs will be $11 and the willingness-to-pay for low quality is $8. (e) Assuming that each producer is able to make the production choice described in the last question, what good would it do if the government banned production of low-quality electric pencil-sharpeners?

If

there is no ban, there will be no output and no consumers’ surplus. If low-quality products are banned, then in equilibrium there is output surplus. 37.2 (0) In West Bend, Indiana, there are exactly two kinds of workers. One kind has a (constant) marginal product worth $10 and the other kind has a (constant) marginal product worth $15. There are equal numbers of workers of each kind. A firm cannot directly tell the difference between the two kinds of workers. Even after it has hired them, it won’t be able to monitor their work closely enough to determine which workers are of which type. (a) If the labor market is competitive, workers will be paid the average value of their marginal product. This amount is

and positive consumers’

$12.50.

(b) Suppose that the local community college offers a microeconomics course in night school, taught by Professor M. De Sade. The highproductivity workers think that taking this course is just as bad as a $3 wage cut, and the low-productivity workers think it is just as bad as a $6 wage cut. The firm can observe whether or not an individual takes the microeconomics course. Suppose that the high-productivity workers all choose to take the microeconomics course and the low-productivity

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workers all choose not to. The competitive wage for people who take the microeconomics course will be

$15

and the wage for people who don’t

take the microeconomics course will be...
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