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Principles of EconomicsChap22 Frontiers of MicroEconomics

2011/9/23

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Index

1. Asymmetric Information

2. Political Economy

3. Behavioral Economics

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1.Asymmetric Information

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HiddenActions:Principals,Agents,and Moral Hazard

•  Moral Hazard: a problem that arise when one person,called the agent,is performing some task on behalf of another person.

ex)The employment relationship

–  Principal:employer

–  Agent :worker

•  Response to the problem

–  Better monitoring

–  High wages

–  Delayed payment

Joseph E. Stiglitz

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Hidden CharactresticsAdverse selection and the lemon problem

•  Adverse selection:a problem that arise in markets in which the sellers know more about the attributes of the goods being sold than the buyer does.

–  the market for used cars

–  labor markets

–  insurance

George Arthur Akerlof

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Signaling and Screeng

•  Signaling: an action taken by an informed party to reveal private information to an uninformed party

–  advertising

–  education

•  Screeing:an action taken by an uniformed party to induce an informed party to reveal information

–  driver's history

–  high premiums and low premiums

Michael Spence

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Market failure

•  externalities(Chap10)

•  public goods(Chap11)

•  imperfect competition(Chap15 through17)

•  poverty(Chap20)

•  [NEW!]asymmetric information(Chap22)

Principles6:

Markets are are usually good way to organize economic activity.

Principles7:

Governments can sometimes improve market outcomes.

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Asymmetric information and Public policy

•  The private markets can sometimes deal with information asymmetries on its own using a combination of signaling and screeing.

•  The government rarely has more information than the private parties.

•  The government is itself an imperfect institution.

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2. Political Economy

Amartya Sen

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Political Economy

•  the study of government using a the analytic methods

•  sometimes called the field of public choice

–  the condorect voting paradox

–  Arrow's impossibility theorem

–  the median voter is King

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the condorect voting paradox

•  the condorect voting paradox:the failure of majority rule to produce transitive preference for society

–  when there are more than two options,setting agenda can have a powerful influence over the outcome of a democratic election.

–  majority voting by itself does not tell us what a outcome a society really wants.

Voter Type

type1 type2 type3

Percent of Electorate 35 45 20

First choice A B C

Second choice B C A

Third choice C A B

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Arrow's impossibility theorem

•  Mathematically and incontrovertibly, that no voting system can satisfy all these following properties. –  Unanimity

–  Transitivity

–  Independence of irrelevant alternatives

–  No dictators

Kenneth Joseph Arrow

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the median voter is King

•  Two poritical parties are each trying to maximize their chance of election,they will both move their positions toward the median voter.

•  Minority views are not given much weight.

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3. Behavioral Economics

Daniel KAHNEMAN

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People aren't always rational

•  People are overconfident.

•  People give too much weight to a small number of vivid observations.

•  People are reluctant to change their minds.

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People care about Fairness

•  ultimatum game

–  Player A's job is to propose a division of the $100 prize between himself and the other player.After player A makes his proposal,player B decides whether to accept or reject it.

•  In the language of game theory, the 99-1 spolt is the Nash equilibrium.

•  It is more common for player A to propose giving player B an amount such as $30 or $40.

John Forbes Nash

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People are inconsistent over time

1. Would you prefer(A) to spend 50 minutes doing the task right now or (B) to spend 60 minutes doing the task tomorrow?

2. Would you prefer (A) to spend 50 minutes doing the task in 90 days or (B) to spend 60 minutes doing the task in 91days?

An implication of this inconsistency overtime is that people should try to find ways to commit their future selves to following through on their plans

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Conclusion

•  The study of asymmetric information should make you more wary of market outcome.

•  The study of political economy should make you more wary of government solutions.

•  The study of behaviral economics should make yo9u wary of any institutions that relies on human decision making,including both the market and the government.