Exam 36: Asymmetric Information

A life insurance company must be concerned about the possibility that the people who buy life insurance may tend to be less healthy than those who do not. This is an example of adverse selection.

The incentive compatibility constraint requires that incentives be consistent with a consumers budget constraint.

An example of adverse selection is the situation where someone chooses a car that is not as good as it is claimed to be.

In Rustbucket, Michigan, there are 200 used cars for sale; half of these cars are good and half of them are lemons. Owners of lemons are willing to sell them for $500. Owners of good used cars are willing to sell them for prices above $1,300 but will keep them if the price is lower than $1,300. There is a large number of potential buyers who are willing to pay $600 for a lemon and $2,300 for a good car. Buyers can't tell good cars from bad, but original owners know.

There are two types of used cars, high quality and low quality. Buyers cannot distinguish the two types until after they have purchased them. Owners of high-quality cars will sell them if the price is $2,000 or higher. Owners of low-quality cars will sell them if the price is $1,000 or higher. Buyers value a high-quality used car at $3,466 and a low-quality used car at $1,200. Suppose that 30% of used cars are of high quality and 70% of used cars are of low quality. In equilibrium,

A certain city has two kinds of workers, alphas and betas. An alpha can produce $100 worth of output per day working for himself. If he works in the local factory, he produces $120 worth of output a day. A beta produces $60 worth of output per day working for himself, and he produces $80 worth of output per day if he works for the local factory. Workers either work for themselves or work in the factory. The factory owner can't tell alphas from betas. He pays a wage equal to the average product of his labor force and he has at least some alphas working for him. Workers are free to choose to work for themselves or the factory, depending on which offers more money.

In Rustbucket, Michigan, there are 200 used cars for sale; half of these cars are good and half of them are lemons. Owners of lemons are willing to sell them for $500. Owners of good used cars are willing to sell them for prices above $1,100 but will keep them if the price is lower than $1,100. There is a large number of potential buyers who are willing to pay $600 for a lemon and $1,700 for a good car. Buyers can't tell good cars from bad, but original owners know.

In a market where there is a separating equilibrium, different types of agents make different choices of actions.

Suppose that low-productivity workers all have marginal products of 10 and high-productivity workers have marginal products of 16. The community has equal numbers of each type of worker. The local community college offers a course in microeconomics. High-productivity workers think taking this course is as bad as a cut in wages of $5 and low-productivity workers think it is as bad as a wage cut of $9.

Suppose that low-productivity workers all have marginal products of 10 and high-productivity workers have marginal products of 16. The community has equal numbers of each type of worker. The local community college offers a course in microeconomics. High-productivity workers think taking this course is as bad as a cut in wages of $5 and low-productivity workers think it is as bad as a wage cut of $9.

There are two types of used cars, high quality and low quality. Buyers cannot distinguish the two types until after they have purchased them. Owners of high-quality cars will sell them if the price is $2,000 or higher. Owners of low-quality cars will sell them if the price is $1,000 or higher. Buyers value a high-quality used car at $4,266 and a low-quality used car at $1,200. Suppose that 30% of used cars are of high quality and 70% of used cars are of low quality. In equilibrium,