Economics of Information

Background N/2 cars in the market are plums N/2 cars are lemons Plums cost 6 per car to make Lemons cost 2 per car to make Buyers will pay 6 for a plum at the most And 2 for a lemon at the most

0000 x-2 2-x lemon plum Y N 0000 Y N x-6 6-x 1 22 x x Y means accept N means reject x is the offered price x  11 Seller Buyer

0000 x-2 2-x lemon Y N 0000 Y N x-2 2-x 1 22 x x Y means accept N means reject x is the offered price x  11 Seller Buyer

Perceived Quality... Price Minimum Supply Price. Maximum Demand Price

Perceived Quality. Price Minimum Supply Price. Maximum Demand Price.

Perceived Quality. Price Minimum Supply Price. Maximum Demand Price Equilibrium

0 5 X f(X) 1/5 For every value of X, f(X) = 1/5 2.5 The Expected Value of X = 2.5 X represents value of car So the intial perceived value = 2.5 Maximum intial price = 2.5

0 X f(X) 1/2.5 For every value of X, f(X) = 1/ The Expected Value of X = 1.25 X represents value of car So the perceived value =1.25 Maximum price = The only information Equilibrium is at price= 0 !

Background N/2 cars in the market are plums N/2 cars are lemons Plums cost 5 per car to make Lemons cost 0 per car to make Buyers will pay 6 for a plum at the most And 1 for a lemon at the most A warranty costs w if implemented

p-5 6-p p-w 6-p W NW lemonplum 1 W stand for warranty p p q-5 6-q q 1-q plum q q lemon y y y y n nnn

2 plays p=6 And q=1 A plum plays W and y If w >5, a separating Equilibrium exists A lemon plays NW and y

Background Half the cars in the market are plums The remaining half are lemons Plums cost 5 per car to make Lemons cost 0 per car to make Buyers will pay 6 for a plum at the most And 1 for a lemon at the most A warranty costs w1 for a plum and w2 for a lemon (w1 < w2)

p-5-w1 6-p p-w2 1-p W NW lemonplum 1 W stand for warranty p p q-5 6-q q 1-q plum q q lemon y y y y n nnn

If w1 5, a separating equilibrium exists A plum plays W and y A lemon plays NW and y 2 plays p=6 and q=1

Background N/2 cars in the market are plums N/2 cars are lemons Plums cost 0 per car to make Lemons cost 0 per car to make Buyers will pay 6 for a plum at the most And 1 for a lemon at the most A warranty costs w1 for a plum and w2 for a lemon

p-w1 6-p p-w2 1-p W NW lemonplum 1 W stand for warranty p p q 6-q q 1-q plum q q lemon y y y y n nnn

If w1 > 6 and w2 > 6, a pooling equilibrium exists A plum plays NW and y A lemon plays NW and y 2 plays p=6 and q=3.5

Background N/2 employees have high productivity H N/2 employees have low productivity L A degree costs d1 to high productivity workers and d2 to low productivity with d1 < d2

p-d1 H-p p-d2 L-p D ND Low High 1 D stand for degree p p q H-q q L-q High q q Low y d2 0 -d1 0 y y y n nnn

If H-L > d1 and yet H-L < d2, a separating equilibrium exists High productivity workers play D and y Low productivity workers play ND and y 2 plays p=H and q= L Net output = N/2*H + N/2*L – N/2*d1

But if d1 and d2 are too high, say d1, d2 > H a pooling equilibrium exists High productivity workers play ND and y Low productivity workers play ND and y 2 plays p=H and q= (H+L)/2 Net output = N/2*H + N/2*L So a pooling equilibrium, if it exists, is more resource efficient