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Chapter 38 95
Chapter 38
Information
The students really like this material on information economics, but you have
to work at it to really get the ideas across.
The first topic is the famous lemon’s market. I found it easy to get the idea
across, but the logic needs emphasizing. That’s why I go through the quality
choice model in the next section. The first part of this model is basically the
same idea, but in a different context. I then summarize the fundamental idea—
the idea of adverse selection. Here it is fun to discuss other examples of adverse
selection.
The next topic is that of moral hazard. Again, it is useful to discuss other
examples to make sure the students have the idea straight.
The third topic is signaling. The Spence educational signaling model is a
wonderful example for college students. In particular, be sure to discuss the
“sheepskin effect” example given in the text. It seems that the diploma must
carry signaling value, over and above the actual learning that it represents; your
class may want to discuss just what a diploma signals.
Finally, I discuss the topic of incentives. The basic thing to get across here
is the equivalence of all the compensation schemes in the presence of symmetric
information. The idea that sharecropping can be an efficient incentive scheme
when information is imperfect is a nice insight that deserves emphasis.
Information
A. Up until now, we have assumed complete information — consumers and firms
know the quality of the goods they buy and sell
B. But in real life, information may often be incomplete
C. Then people have to infer quality from price or other signals
D. Firms may supply such signals intentionally or inadvertently
96 Chapter Highlights
E. Model of used-car market
1. 50 lemons for sale, 50 plums
2. buyers willing to pay $2,400 for plum, $1,200 for lemon
3. sellers will sell plum for $2,000 and lemon for $1,000
4. full information solution
5. incomplete information solution
a) can’t tell if car is a plum or a lemon
e) at this price, the owners of plums wouldn’t sell
f) only owners of lemons would sell
F. Quality choice
1. in the lemons model, quality is exogenous; what if quality is endogenous?
2. umbrella market
c) suppose it costs $11.50 to produce high quality and $11 to produce low
quality
3. Adverse selection
a) consider insurance market
b) people who need insurance the most are more likely to buy it
Chapter 38 97
G. Signaling
1. we have seen that when quality in market is mixed, the bad quality can
drive out the good
6. example—signaling by educational choice
a) two kinds of workers, able and unable
b) able have MP of a2, unable have an MP of a1,anda2>a
1.
