Asymmetric Information
Chapter 37
NAME
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.
454
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
NAME
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.
454
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