Limited Information

May 6, 2013

How was the exam?

A. EasyB. Just RightC. Hard / FairD. Too Hard / Not Fair

What was most useful?

A. Practice examsB. Homework assignmentsC. Class notesD. Not one more than others

What was least useful?

A. Practice examsB. Homework assignmentsC. Class notesD. Not one more than others

Announcements

• TAs are still grading exams– We’ll let you know when they’re ready and how to

see your score.• Two homework assignments now posted.– Ch 12 (material covered this week in class) due

this Friday, May 10– Ch 13 (material covered next week in class) due

this Monday, May 13

Last Class

• Finished our discussion of externalities• Key understanding: How efficiency can be

restored when externality causes inefficiency• Restoring efficiency was also underlying

motivation when studying– market power– games

• Recall: ``efficiency’’ = perfect competition outcome

Perfectly competitive markets

• Firms have no influence over what the going price in the market is.– ``Price-takers.’’

• Characteristic of perfectly competitive markets:– All firms sell the same (really the same!) product.– There are many buyers and sellers.– There are no costly barriers to starting a business.– Both consumers and firms are well-informed.

Perfectly competitive markets

• Firms have no influence over what the going price in the market is.– ``Price-takers.’’

• Characteristic of perfectly competitive markets:– All firms sell the same (really the same!) product.– There are many buyers and sellers.– There are no costly barriers to starting a business.– Both consumers and firms are well-informed.

Learning Goals for Today

• Be able to list many markets where consumers have limited information

• Same for producers• Explain the sources of the free-rider problem

in this context.

What is ``Incomplete Information?’’

• First, what is the worth of ``complete information’’ to the consumer?– Consumers can make rational decisions about

marginal benefits (the demand line!)• How about to the producer?– Producers can make rational decisions about

marginal costs (the supply line!)

How much are you willing to pay for a small cup of coffee?

A. $0-0.50B. $0.50-1C. $1-1.50D. $1.50-2E. $2+

Here you go.A. $0-0.50B. $0.50-1C. $1-1.50D. $1.50-2E. $2+

Asymmetric InfoHow small is ``small?’’

Consider the opposite ifyou were a seller: how largeis ``small’’?

Markets with Incomplete Information

ConsumersProducers

Spend a minute and try to think of some / write some down.

In which consumer market is information most valuable?

ConsumersProducers

In which producer market is information most valuable?

ConsumersProducers

Lemons

• Cars, or other consumer items, that have hidden problems are known as “lemons.’’

• Why is it hard to tell in the case of a car?

Your reservation price for a good used car is $5000. For a lemon is $1000. Given 20% of all cars are

lemons, we can predict that

• only lemons sell, for $1k each.• both types of cars sell, for $4200 each.• only good cars sell, fro $4200 each.• both reliable cars and lemons will sell for $1k

each.

Expected Value

• You can’t tell if a car is a lemon.• Therefore, your valuation is its expected value.• -> Should pay its expected value.

How much information?.

Markets that people Markets that people research before buying. research until MB=MC.

Will the Market Provide the Optimal Level of Information?

• In theory, information could be bought and sold just like any other good or service.

• BUT because information can be easily transferred from one person to the next, it’s hard to keep people who don’t pay for information from benefitting from it.

• Leads to a free-rider problem: any situation in which too little of a good or

service is produced because you can’t exclude people who don’t pay for a good or service from benefitting from it.

Will the Market Provide the Optimal Level of Information?

• People’s individual willingness to pay for information will be less than the social benefit of the information (since the information can costless be transferred to others). – Similar to the existence of a positive externality

• Markets will provide too little information.

Will the Market Provide the Optimal Level of Information?

• Example: go to Best Buy to learn about HDTVs, then buy online.– Best Buy covers the cost of the information it provides by

charging a little more.– If no one willing to pay the extra for a TV from Best Buy, Best

Buy will have a hard time providing good customer service.

Show-Rooming

Rise of smart-phones has resulted in consumers going to individual stores, and then searching for same product online to find similar prices.

What are some examples?

Show-Rooming

Rise of smart-phones has resulted in consumers going to individual stores, and then searching for same product online to find similar prices.

What is the ``story?’’

Show-Rooming

Rise of smart-phones has resulted in consumers going to individual stores, and then searching for same product online to find similar prices.

How do we think about it economically?