Asymmetric Information Asymmetric Information is when parties are not equally informed. For instance, with the sale of a good, the seller may know the.

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Presentation transcript:

Asymmetric Information Asymmetric Information is when parties are not equally informed. For instance, with the sale of a good, the seller may know the value better than the buyer. In the classroom experiment, the seller (computer) knows how much it is worth, the buyer (student) does not. The seller is more willing to sell the car if the value is lower than if the value is higher. Thus, for a given price, a buyer is more likely to attract sellers with lower quality goods.

Buyer-Seller Example Value for the seller has an equal chance of being any number between 0 and 100. What is the average value? –50. If the buyer offers a price of 50, for which values will the seller sell? –Values 0 to 50. What is the average of these values? What is 3/2 times the average of these values? –Average 25. This times 3/2 is 37.5.

General Solution. If the buyer offers a price of p, for which values will the seller sell. –0 to p. What is 3/2 times the average of these values? –Average is p/2. This times 3/2 is (3/4) p. On average, how much will the buyer make if he values the object 3/2 times the seller. What should the buyer do? –3/2 * p/2 –p=3/4 p –p= -p/4. Set p=0. Moral of the story: Sometimes a best deal is one not made.

Applications Akelof recognized this problem in that used cars tend to be lemons. That is the seller knows more about the condition than the buyer. This is one reason why as soon as one leaves the dealer with a new car it has a significant drop in value.

More applications:Takeovers Why do takeovers rarely benefit the companies? Often the target can benefit from the advantage of the other company: management, size, bringing products to market. Case study: Chromatis. –Founded by Israelis in Sold to Lucent in 2000 for $4.8 billion. –Revenue generated for Lucent: 0. Lucent closed Chromatis in Shortly after for financial reasons Lucent also for the most part dismantled Bell Labs. –Where the transistor, laser, Unix, C, etc. was developed. 6 Nobel prizes for work..

Homework Question In the takeover game, assume that the value for the seller is uniformly distributed between 50 and 100. Assume that it is still worth to the buyer 3/2 times the sellers value. What should the buyer offer to the seller?