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Chapter 22

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Economics 10a
Gregory Mankiw

Chapter 22 Economics: Frontiers of Microeconomics • Economics of asymmetric information: a difference in access to relevant knowledge o The uninformed party would like to know the relevant information, but the informed party (the worker, the car seller) may have an incentive to conceal it  Hidden action: an employee knows how hard he works  Hidden characteristic: a salesman knows the product’s defects o Moral hazard: the tendency of a person who is imperfectly monitored to engage in dishonest or otherwise undesirable behavior o Agent: a person who is performing an act for another person, called the principal o Principal: a person for whom another person, called the agent, is performing some act o How to respond to the Moral Hazard Problem (preventing “immoral” behavior from the agent:  Better monitoring  High wages: The efficiency-wage theories state that some employers may choose to pay above the equilibrium value as this incites a better work ethic from the worker (he is less likely to find another high paying job if he is caught shirking work)  Delayed payment: like a year-end bonus for good work o Adverse selection: the tendency for the mix of unobserved attributes to become undesirable from the standpoint of an uninformed party (ex. Used car market)  When a firm cuts the wage it pays, the more talented workers are more likely to quit, knowing they are better able to find other employment; a firm may also choose to pay above equilibrium to ensure the best workers  The price of health insurance reflects the costs of sicker-than-average persons o Signaling: an action taken by an informed party to reveal private information to an uninformed party  Ex.Advertising (people will buy the product and if it is good will become repeat customers; college degrees signify one’s determination and talent, indicating higher productivity)  The signal will be costly but must be less costly/more beneficial to the person with the higher-quality product, incentivizing the signaling process o People care most about the custom when the strength of affection is most in question o Screening: an action taken by an uninformed party to induce an informed party to reveal information  Ex. Buying a used car and having it checked out by a trusted mechanic or having levels of deductibles available for risky vs. safe drivers to choose from (it’s self- selecting) o When some people know more than others, the markets may fail to put resources to their best use o Asymmetric information and the government:  The private market can sometimes deal with information asymmetries on its own using a combination of signaling and screening  The government rarely has more information than the private partiespolicy makers may find it hard to improve upon the market’s imperfect outcome  The government is an imperfect institution • Corporation: an organization that is granted a charter recognizing it as a separate legal entity with its own rights and responsibilities distinct from those of its owners and employees o There is a separation of ownership and control: stockholders own it and mangers are employed by the corporation to make decision about how to deploy the corporation’s resources  Managers are charged with profit maximizing  The board of directors manages the managers’performance • Political economy: the study of government using the analytic methods of economics o The government is also an imperfect institution o Condorcet Paradox: the failure of majority rule to produce transitive preferences for society  Pairwise voting: puttingAagainst B and B against C  Majority voting does not tell us what society really wants o Arrow’s impossibility theorem: a mathematical result showing that, under certain assumed conditions, there is no scheme for aggregating individual preferences into a valid set of social preferences  Borda count: voters rank candidates and then assign points on a sliding scale, with the
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