1、Managerial Economics,Zhigang Tao,1,Managerial Economics,Zhigang Tao,2,Asymmetric Information,asymmetric v imperfect informationstrategic misrepresentationadverse selectionappraisalscreeningsignaling,Managerial Economics,Zhigang Tao,3,Question-1,“Life insurance for everyone: No questions asked, no me
2、dical examination.” Good or bad deal?,Managerial Economics,Zhigang Tao,4,Question-2,Suppose a medical insurer decides to cover pregnancy, should it offer pregnancy as an option or as part of the basic program?,Managerial Economics,Zhigang Tao,5,Question-3,How to convince a potential employer that yo
3、u are loyal and productive?,Managerial Economics,Zhigang Tao,6,Imperfect Information,distinguish:imperfect informationasymmetric informationrisk: uncertainty about benefits or costsarises from imperfect information risk aversioninsurance,Managerial Economics,Zhigang Tao,7,Bargain Over a Trade,The bu
4、yers value is expected to be either $1 (20%) or $3 (80%). The sellers cost is expected to be either $0 (80%) or $2 (20%). Only the buyer knows the true value, and only the seller knows the true cost.,Managerial Economics,Zhigang Tao,8,Efficient Outcomes,Managerial Economics,Zhigang Tao,9,Strategic M
5、isrepresentation,Sometimes it is impossible to find any prices that always make it in the parties individual interest to report truthfully and to trade whenever trade is value increasing. Efficient trade is more difficult to achieve when the probability of seller (buyer) having low cost (high value)
6、 is higher.,Managerial Economics,Zhigang Tao,10,A Paradox,It is possible and profitable for one or both trading parties to gain a bargaining advantage by investing in information about the quality of the good. However, private information may completely prevent agreement even though there are signif
7、icant gains to be had from trade.,Managerial Economics,Zhigang Tao,11,The De Beers Practice,Buyers are offered a packet of stones, called “sight”, that roughly corresponds to their indicated interests. The stones are graded and sorted on the basis of their gross characteristics only, without any att
8、empt by De Beers to estimate their value closely.,Managerial Economics,Zhigang Tao,12,Please be assured,prepackaging fruits and vegetables in grocery stores “block-booking” a set of movies from a given studiopaying percentage royalties to book authorssupplying products with warranties and money-back
9、 guarantees,Managerial Economics,Zhigang Tao,13,Adverse Selection,Besides the incentive to misrepresent valuations, a second sort of problem arising from asymmetric information is adverse selection.Economic inefficiencyPossible market failure,Managerial Economics,Zhigang Tao,14,Antique Market,1000 f
10、akes and Q thousand genuine itemsActual marginal benefit is (Q - 1) / Q of the marginal benefit for genuine antiques.equilibrium,Managerial Economics,Zhigang Tao,15,0,2,3,5,7,8,1,2,3,8,supply of genuine antiques,combined supply of genuineand fake antiques,actual demand(marginal benefit),demand (marg
11、inal benefit)for genuine antiques,Quantity (Thousand units a month),Price (Hundred $ per unit),Market with Adverse Selection,Managerial Economics,Zhigang Tao,16,0,2,8,F,8,c,d,combined supply of genuine and fake antiques,actual demand(marginal benefit),demand (marginal benefit)for genuine antiques,Qu
12、antity (Thousand units a month),Price (Hundred $ per unit),Market Failure,Managerial Economics,Zhigang Tao,17,Adverse Selection in Lending,A has a project generating $110 (100%). B has a project generating $0 (50%) and $220 (50%). Both projects need $100 investment.Both will borrow when the interest
13、 rate is 5%. But only B will borrow when the interest rate is 15%, for which the bank will suffer a loss.,Managerial Economics,Zhigang Tao,18,Health Insurance,Expected claim payment, x, is uniformly distributed over 0,1. The insurance policy also offers value, v, for pure risk reduction.The insuranc
14、e provider (seller) incurs a percentage cost, c, for claim administration.The seller offers same price to all potential buyers.,Managerial Economics,Zhigang Tao,19,Mandatory Coverage?,A buyer will purchase the policy if the price is no greater than x+v. The average insurance expense to the seller is
15、 (x+1)(1+c)/2.If cv, there is no private insurance.If cvc/2, mandatory coverage to the whole population is desirable.,Managerial Economics,Zhigang Tao,20,Appraisal,Characteristic is objectively verifiable.Potential gain covers appraisal cost.Procuring the appraisal: buyer or seller?number of buyersi
16、nformation requirements,Managerial Economics,Zhigang Tao,21,Examples,rating agencies (Moody, S&P)transcripts, reference lettersexpert evaluation (car, antique)credit checks and employment reportsmedical checkup for insurance coverage,Managerial Economics,Zhigang Tao,22,Screening,Less informed party
17、indirectly elicits other partys characteristics.Better informed parties are differentially sensitive to some variable that less informed can control.structure choices to induce self-selection,Managerial Economics,Zhigang Tao,23,Examples,age/wage profiles and employee turnoverperformance pay and prod
18、uctivitymenus of contracts (a whole line of related products, a variety of insurance coverage, a menu of wage contracts)benefits (employee discounts)auction,Managerial Economics,Zhigang Tao,24,A Bible Story,The King said, “Divide the living child into two, and give half to the one, and half to the o
19、ther.” Then the woman whose son was alive said , “Oh, my lord, give her the living child, and by no means slay it.” But the other said, “It shall be neither mine nor yours; divide it.” (1 King 3, verses 16-27, Revised Standard Version),Managerial Economics,Zhigang Tao,25,Indirect Segment Discriminat
20、ion,restricted v unrestricted air faresbundled v separate channelswholesale price cuts v cents-off coupons,Managerial Economics,Zhigang Tao,26,Screening Not Permitted,In criminal trials, the court can draw a negative inference about one who elects not to testify. American and English criminal courts
21、, however, allow every defendants the right to remain silent and prevent the court from inferring anything from the defendants decision.,Managerial Economics,Zhigang Tao,27,Signaling,Better informed party communicates characteristics in a credible way.Cost of signal differs according to characterist
22、ics.Self-selection ensures that signal is credible.,Managerial Economics,Zhigang Tao,28,Examples,education as a signal of innate abilitiesoffering product warranties and money-back guarantees as a signal of product qualitysetting low “limit” prices as a signal of low costspaying dividends to signal
23、financial strength,Managerial Economics,Zhigang Tao,29,Advertising and Reputation,The advertising expenditure must be irreversible.Buyers must be able to detect poor quality fairly quickly (rust-free car body).Word of poor quality must spread and cut into the sellers future business (fast food resta
24、urants along highways).,Managerial Economics,Zhigang Tao,30,Branding,If one station provides poor service, it affects all other units with the same name.In Eastern Massachusetts, stations along highways were 19% more likely to be affiliated with a major brand than stations off highways.,Managerial Economics,Zhigang Tao,31,Countertrade,The foreign supplier of production technology and equipment is required to buy back a specified quantity of future production of the manufactured item.Screening and/or Signaling,
