Frank Cowell: Signalling SIGNALLING MICROECONOMICS Principles and Analysis Frank Cowell Almost essential Risk Almost essential Risk Prerequisites July.

Slides:



Advertisements
Similar presentations
1 Signalling Often a player wants to convey his private information to other players. It might be information about his own payoffs (My costs are low,
Advertisements

Price Discrimination RESERVATION PRICE: A customer's reservation price is the most he is willing to pay for a unit of purchase. If I will pay up to 12.
Optimal Contracts under Adverse Selection
Hal Varian Intermediate Microeconomics Chapter Thirty-Six
ECON 100 Tutorial: Week 9 office: LUMS C85.
Chapter 37 Asymmetric Information In reality, it is often the case that one of the transacting party has less information than the other. Consider a market.
Stackelberg -leader/follower game 2 firms choose quantities sequentially (1) chooses its output; then (2) chooses it output; then the market clears This.
Frank Cowell: Microeconomics Exercise 11.1 MICROECONOMICS Principles and Analysis Frank Cowell March 2007.
Factor Markets and the Distribution of Income
Frank Cowell: Microeconomics Market Power and Misrepresentation MICROECONOMICS Principles and Analysis Frank Cowell September 2006.
Imperfect commitment Santiago Truffa. Agenda 1.“Authority and communication in Organizations” Wouter Dessein, RES “Contracting for information.
Adverse Selection Asymmetric information is feature of many markets
Simultaneous games with continuous strategies Suppose two players have to choose a number between 0 and 100. They can choose any real number (i.e. any.
A camper awakens to the growl of a hungry bear and sees his friend putting on a pair of running shoes, “You can’t outrun a bear,” scoffs the camper. His.
Frank Cowell: Efficiency-Waste EFFICIENCY: WASTE MICROECONOMICS Principles and Analysis Frank Cowell Almost essential Welfare and Efficiency Almost essential.
Objectives © Pearson Education, 2005 Oligopoly LUBS1940: Topic 7.
Chapter 7 General Equilibrium and Market Efficiency
Asymmetric Information ECON 370: Microeconomic Theory Summer 2004 – Rice University Stanley Gilbert.
Chapter 9 THE ECONOMICS OF INFORMATION Copyright ©2002 by South-Western, a division of Thomson Learning. All rights reserved. MICROECONOMIC THEORY BASIC.
BEE3049 Behaviour, Decisions and Markets Miguel A. Fonseca.
Static Games and Cournot Competition
Job Market Signaling (Spence model)
TOPIC 6 REPEATED GAMES The same players play the same game G period after period. Before playing in one period they perfectly observe the actions chosen.
Asymmetric Information
Extensive Game with Imperfect Information III. Topic One: Costly Signaling Game.
Extensive Game with Imperfect Information Part I: Strategy and Nash equilibrium.
EC941 - Game Theory Francesco Squintani Lecture 3 1.
Introduction to the economics of education
Introduction: Thinking Like an Economist 1 CHAPTER 2 CHAPTER 12 The Logic of Individual Choice: The Foundation of Supply and Demand The theory of economics.
Frank Cowell: Microeconomics Exercise 11.3 MICROECONOMICS Principles and Analysis Frank Cowell March 2007.
Principal - Agent Games. Sometimes asymmetric information develops after a contract has been signed In this case, signaling and screening do not help,
© 2005 Worth Publishers Slide 12-1 CHAPTER 12 Factor Markets and the Distribution of Income PowerPoint® Slides by Can Erbil and Gustavo Indart © 2005 Worth.
Chapter 37 Asymmetric Information. Information in Competitive Markets In purely competitive markets all agents are fully informed about traded commodities.
Asymmetric Information
Slides Industrial Organization: Markets and Strategies Paul Belleflamme and Martin Peitz © Cambridge University Press 2009 Part V. Product quality and.
The Moral Hazard Problem Stefan P. Schleicher University of Graz
Frank Cowell: Microeconomics Repeated Games MICROECONOMICS Principles and Analysis Frank Cowell January 2007 Almost essential Game Theory: Dynamic Almost.
Frank Cowell: Microeconomics Signalling MICROECONOMICS Principles and Analysis Frank Cowell Almost essential Risk Almost essential Risk Prerequisites.
Chapter 5 Signalling Stefan P. Schleicher University of Graz Economics of Information Incentives and Contracts.
Frank Cowell: Microeconomics Exercise 3.3 MICROECONOMICS Principles and Analysis Frank Cowell November 2006.
Frank Cowell: Microeconomics Contract Design MICROECONOMICS Principles and Analysis Frank Cowell Almost essential Adverse selection Almost essential Adverse.
© 2010 W. W. Norton & Company, Inc. 37 Asymmetric Information.
Asymmetric Information
Investment in Human Capital Model-Part I Topic 3 Part III.
Extensive Games with Imperfect Information
Lecture 5 Financial Incentives This lecture is paired with our previous one that discussed employee benefits. Here we focus on the reasons why monetary.
1 Consumer Choice and Demand CHAPTER 6 © 2003 South-Western/Thomson Learning.
Decision theory under uncertainty
© 2010 Institute of Information Management National Chiao Tung University Chapter 7 Incentive Mechanism Principle-Agent Problem Production with Teams Competition.
Introduction Many organizations use decision rules to alleviate incentive problems as opposed to incentive contracts The principal typically retains some.
Frank Cowell: Games Uncertainty GAMES: UNCERTAINTY MICROECONOMICS Principles and Analysis Frank Cowell Almost essential Games: Mixed Strategies Almost.
The Logic of Individual Choice: The Foundation of Supply and Demand 10 The Logic of Individual Choice: The Foundation of Supply and Demand The theory of.
Frank Cowell: Contract Design CONTRACT DESIGN MICROECONOMICS Principles and Analysis Frank Cowell July Almost essential: Adverse selection Almost.
Frank Cowell: Microeconomics Moral Hazard MICROECONOMICS Principles and Analysis Frank Cowell Almost essential Risk Almost essential Risk Prerequisites.
MICROECONOMICS Principles and Analysis Frank Cowell
Review Monopoly Summary A monopoly is a firm that is the sole seller in its market. It faces a downward-sloping demand curve for its product. A.
Frank Cowell: Market Power & Misrepresentation MARKET POWER AND MISREPRESENTATION MICROECONOMICS Principles and Analysis Frank Cowell July Note:
Frank Cowell: Adverse Selection ADVERSE SELECTION MICROECONOMICS Principles and Analysis Frank Cowell July Almost essential Risk Risk-taking Almost.
Frank Cowell: Design Basics DESIGN BASICS MICROECONOMICS Principles and Analysis Frank Cowell 1 Almost essential Welfare Basics Games: equilibrium Almost.
Frank Cowell: Microeconomics Signalling MICROECONOMICS Principles and Analysis Frank Cowell Almost essential Risk Almost essential Risk Prerequisites.
Chapter Thirty-Six Asymmetric Information. Information in Competitive Markets u In purely competitive markets all agents are fully informed about traded.
Chapter 8: The Labor Market
Shane Murphy ECON 102 Tutorial: Week 9 Shane Murphy
Q 2.1 Nash Equilibrium Ben
Consumers, Producers, and the Efficiency of markets
Asymmetric Information
Asymmetric Information
MICROECONOMICS Principles and Analysis Frank Cowell
Adverse Selection May 2004 Almost essential Risk Risk-taking
Chapter 38 Asymmetric Information
Presentation transcript:

Frank Cowell: Signalling SIGNALLING MICROECONOMICS Principles and Analysis Frank Cowell Almost essential Risk Almost essential Risk Prerequisites July

Frank Cowell: Signalling Introduction  A key aspect of hidden information  Information relates to personal characteristics hidden information about actions is dealt with under “moral hazard”  But a fundamental difference from screening informed party moves first opposite case (where uninformed party moves first) dealt with under “adverse selection”  Nature of strategic problem uncertainty about characteristics: game of imperfect information updating by uninformed party in the light of the signal equilibrium concept: perfect Bayesian Equilibrium (PBE) July

Frank Cowell: Signalling Signalling  Agent with the information makes first move: subtly different from other “screening” problems move involves making a signal  Types of signal could be a costly action (physical investment, advertising, acquiring an educational certificate) could be a costless message (manufacturers' assurances of quality, promises by service deliverers)  Message is about a characteristic this characteristic cannot be costlessly observed by others let us call it “talent” July

Frank Cowell: Signalling Talent  Suppose individuals differ in terms of hidden talent τ  Talent is valuable in the market but possessor of τ cannot convince buyers in the market without providing a signal that he has it  If a signal is not possible may be no market equilibrium  If a signal is possible will there be equilibrium? more than one equilibrium? July

Frank Cowell: Signalling Overview Costly signals: model Costly signals: equilibrium Costless signals Signalling An educational analogy July

Frank Cowell: Signalling Costly signals  Suppose that a “signal” costs something physical investment forgone income  Consider a simple model of the labour market  Suppose productivity depends on ability ability is not observable  Two types of workers: the able –  a the basic –  b  a >  b  Single type of job employers know the true product of a type  -person if they can identify which is which  How can able workers distinguish themselves from others? July

Frank Cowell: Signalling Signals: educational “investment”  Consider the decision about whether acquire education  Suppose talent on the job identical to talent at achieving educational credentials assumed to be common knowledge may be worth “investing” in the acquisition of credentials  Education does not enhance productive ability simply an informative message or credential flags up innate talent high ability people acquire education with less effort  Education is observable certificates can be verified costlessly firms may use workers'’ education as an informative signal July

Frank Cowell: Signalling Signalling by workers 0 [LOW][HIGH]  [NOT INVEST] [INVEST] [NOT INVEST] [INVEST] f2f2 [low] [high] [low] [high] [low] [high] [low] [high] f1f1 [low][high][low][high] [accept 2] [reject] [accept 1] h … … …  “Nature” determines worker’s type  Workers decide on education  Firms make wage offers  Workers decide whether to accept Examine stages 1-3 more closely  investment involves time and money  simultaneous offers: Bertrand competition hh July

Frank Cowell: Signalling A model of costly signals  Previous sketch of problem is simplified workers only make binary decisions (whether or not to invest) firms only make binary decisions (high or low wage)  Suppose decision involve choices of z from a continuum  Ability is indexed by a person’s type   Cost of acquiring education level z is C(z,  ) ≥ 0 C(0,  ) = 0C z (z,  ) > 0 C zz (z,  ) > 0C z  (z,  ) < 0  Able person has lower cost for a given education level  Able person has lower MC for a given education level  Illustrate this for the two-type case July

Frank Cowell: Signalling Costly signals 0 z C C(,b)C(,b) C(,a)C(,a) z0z0 C(z0,a)C(z0,a) C(z0,b)C(z0,b)  (education, cost)-space  Cost function for an a type  Cost function for a b type  Costs of investment z 0  MC of investment z 0 July

Frank Cowell: Signalling Payoffs to individuals  Talent does not enter the utility function directly individuals only care about income measure utility directly in terms of income: v(y, z;  ) := y  C(z,  ) v depends on τ because talent reduces the cost of net income  Shape of C means that ICs in (z, y)-space satisfy single-crossing condition: IC for a person with talent  is: y =  + C(z,  ) slope of IC for this type is: dy/dz = C z (z,  ) for person with higher talent (  '>  ) slope of IC is: dy/dz = C z (z,  ') but C z  (z,  ) < 0 so IC(  ') is flatter than IC(  ) at any value of z so, if IC(  ') and IC(  ) intersect at (z 0, y 0 ) IC(  ') lies above original IC(  ) for z z 1  This is important to simplify the structure of the problem Example y z high  low  C(z,  ) = (1/  ) z 2 July

Frank Cowell: Signalling Rational behaviour  Workers: assume income y is determined by wage  Wage is conditioned on “signal” that they provide through acquisition of educational credentials  Type-τ worker chooses z to maximise w(z)  C(z,  ) where w( ⋅ ) is the wage schedule that workers anticipate will be offered by firms  Firms: assume profits determined by workers’ talent  Need to design w( ⋅ ) to max profits depends on beliefs about distribution of talents conditional on value of observed signal  What will equilibrium be? July

Frank Cowell: Signalling Overview Costly signals: model Costly signals: equilibrium Costless signals Signalling Costly signals discriminate among agents Separating equilibrium Out-of-equilibrium behaviour Pooling equilibrium July

Frank Cowell: Signalling Separating equilibrium (1)  Start with a separating Perfect Bayesian Equilibrium  Both type-a and type-b agents are maximising so neither wants to switch to using the other's signal  Therefore, for the talented a-types we have  (  a )  C(z a,  a ) ≥  (  b )  C(z b,  a ) if correctly identified, no worse than if misidentified as a b-type  Likewise for the b-types:  (  a )  C(z a,  b ) ≤  (  b )  C(z b,  b )  Rearranging this we have C(z a,  b )  C(z b,  b ) ≥  (  a )   (  b ) positive because  ( ⋅ ) is strictly increasing and  a >  b but since C z > 0 this is true if and only if z a > z b  So able individuals acquire more education than the others July

Frank Cowell: Signalling Separating equilibrium (2)  If there are just two types, at the optimum z b = 0 everyone knows there are only two productivity types education does not enhance productivity so no gain to b-types in buying education  So, conditions for separating equilibrium become C(z a,  a ) ≤  (  a )   (  b ) C(z a,  b ) ≥  (  a )   (  b )  Let z 0, z 1 be the critical z-values that satisfy these conditions with equality z 0 such that  (  b ) =  (  a )  C(z 0,  b ) z 1 such that  (  b ) =  (  a )  C(z 1,  a )  Values z 0, z 1 set limits to education in equilibrium remember that C(0,  )=0 July

Frank Cowell: Signalling 0 z y v(,b)v(,b) z0z0 v(,a)v(,a) z1z1 (a)(a) (b)(b) Bounds to education  IC for an a type  IC for a b type  critical value for a b type  critical value for an a type  both curves pass through (0,  (  b ))  possible equilibrium z -values   (  a ) =  (  b )  C(z 1,  a )   (  a ) =  (  b )  C(z 0,  b ) Separating eqm: Two examples July

Frank Cowell: Signalling Separating equilibrium: example 1 0 v(,b)v(,b) zaza (a)(a) v(,a)v(,a) w()  “bounding” ICs for each type  wage schedule  max type-b’s utility  max type-a’s utility (b)(b)  possible equilibrium z -values  both curves pass through (0,  (  b ))  determines z 0, z 1 as before  low talent acquires zero education z y  high talent acquires education close to z 0 July

Frank Cowell: Signalling Separating equilibrium: example 2 0 v(,b)v(,b) (a)(a) v(,a)v(,a) w()  a different wage schedule  max type-b’s utility  max type-a’s utility (b)(b)  possible equilibrium z -values  just as before  low talent acquires zero education (just as before) z y  high talent acquires education close to z 1 zaza July

Frank Cowell: Signalling Overview Costly signals: model Costly signals: equilibrium Costless signals Signalling More on beliefs Separating equilibrium Out-of-equilibrium behaviour Pooling equilibrium July

Frank Cowell: Signalling Out-of-equilibrium-beliefs: problem  For a given equilibrium can redraw w( ⋅ )-schedule resulting attainable set for the workers must induce them to choose (z a,  (  a )) and (0,  (  b ))  Shape of the w( ⋅ )-schedule at other values of z? captures firms' beliefs about workers’ types in situations that do not show up in equilibrium  PBE leaves open what out-of-equilibrium beliefs may be July

Frank Cowell: Signalling Perfect Bayesian Equilibria  Requirements for PBE do not help us to select among the separating equilibria try common sense?  Education level z 0 is the minimum-cost signal for a-types a-type's payoff is strictly decreasing in z a over [z 0, z 1 ] any equilibrium with z a > z 0 is dominated by equilibrium at z 0  Are Pareto-dominated equilibria uninteresting? important cases of strategic interaction that produce Pareto-dominated outcomes need a proper argument, based on the reasonableness of such an equilibrium July

Frank Cowell: Signalling Out-of-equilibrium beliefs: a criterion  Is an equilibrium at z a > z 0 “reasonable”? requires w() that sets w(z′) <  (  a ) for z 0 < z′ < z a so firms must be assigning the belief π(z′)>0  Imagine someone observed choosing z′ b-type IC through (z′,  (  a )) lies below the IC through (0,  (  b )) a b-type knows he’s worse off than in the separating equilibrium a b-type would never go to (z′,  (  a )) so anyone at z′ out of equilibrium must be an a-type  An intuitive criterion: π(z′) = 0 for any z′  (z 0, z a )  So only separating equilibrium worth considering is where a-types are at (z 0,  (  a )) b-types are at (0,  (  b )) July

Frank Cowell: Signalling Overview Costly signals: model Costly signals: equilibrium Costless signals Signalling Agents appear to be al the same Separating equilibrium Out-of-equilibrium behaviour Pooling equilibrium July

Frank Cowell: Signalling Pooling  There may be equilibria where the educational signal does not work no-one finds it profitable to "invest" in education? or all types purchase the same z? depends on distribution of  and relationship between marginal productivity and   All workers present themselves with the same credentials so they are indistinguishable firms have no information to update their beliefs  Firms’ beliefs are derived from the distribution of  in the population this distribution is common knowledge  So wage offered is expected marginal productivity E  (  ):=[1   ]  (  a ) +  (  b )  Being paid this wage might be in interests of all workers Example July

Frank Cowell: Signalling 0 z y v(,b)v(,b) z0z0 v(,a)v(,a) z1z1 (a)(a) (b)(b) E ()E () No signals: an example  possible z- values with signalling  outcome under signalling  outcome without signalling  highest a-type IC under signalling  both pass through (0, E  (  ))  the type-b IC must be higher than with signalling  but, in this case, so is the type-a IC z0z0  should school be banned? July

Frank Cowell: Signalling  critical z for b-type to accept pooling payoff 0 z y v(,b)v(,b) z2z2 (a)(a) (b)(b) E ()E () Pooling: limits on z?  critical IC for a b-type  E  (  ) = [1  ]  (  a  +  (  b )  expected marginal productivity  [1  ]  (  a ) +  (  b )  C(z 2,  b ) =  (  b )  b-type payoff with 0 education  viable z -values in pooling eqm July

Frank Cowell: Signalling Pooling equilibrium: example 1 0 z y v(,b)v(,b)v(,a)v(,a) w() z*z* (a)(a) (b)(b) E ()E ()  expected marginal productivity  viable z- values in pooling eqm  wage schedule  utility maximisation  equilibrium education July

Frank Cowell: Signalling Pooling equilibrium: example 2 0 z y v(,b)v(,b)v(,a)v(,a) w() z*z* (a)(a) (b)(b)  expected marginal productivity  viable z- values in pooling eqm  wage schedule  utility maximisation  equilibrium education E ()E ()  but is pooling consistent with out-of-equilibrium behaviour? July

Frank Cowell: Signalling 0 z y v(,b)v(,b) z0z0 v(,a)v(,a) (a)(a) (b)(b) E ()E () z'z'z*z* Intuitive criterion again  a pooling equilibrium  a critical z -value z'  E  (  )  C(z *,  b ) =  (  a )  C(z′,  b )  wage offer for an a-type at z 0 > z'  max b-type utility at z 0  max a-type utility at z 0  b-type would not choose z 0  under intuitive criterion  (z 0 ) = 0  a-type gets higher utility at z 0  would move from z* to z 0  so pooling eqm inconsistent with intuitive criterion July

Frank Cowell: Signalling Overview Costly signals: model Costly signals: equilibrium Costless signals Signalling An argument by example July

Frank Cowell: Signalling Costless signals: an example  Present the issue with a simplified example general treatments can be difficult  N risk-neutral agents share in a project with output q =  [z 1 ×z 2 ×z 3 ×...] where 0 < α < 1 z h = 0 or 1 is participation indicator of agent h  Agent h has cost of participation c h (unknown to others) c h  [0,1] it is common knowledge that prob(c h ≤ c) = c  Output is a public good, so net payoff to each agent h is q  c h  Consider this as a simultaneous-move game what is the NE? improve on NE by making announcements before the game starts? July

Frank Cowell: Signalling Example: NE without signals  Central problem: each h risks incurring cost c h while getting consumption 0  If π is the probability that any other agent participates, payoff to h is  −c h with probability [  ] N−1 −c h otherwise  Expected payoff to h is  [  ] N−1 − c h  Probability that expected payoff is positive is  [  ] N−1 but this is the probability that agent h actually participates therefore  =  [  ] N−1 this can only be satisfied if  = 0  So the NE is z h = 0 for all h, as long as α < 1 July

Frank Cowell: Signalling Example: introduce signals  Introduce a preliminary stage to the game  Each agent has the opportunity to signal his intention: each agent announces [YES] or [NO] to the others each agent then decides whether or not to participate  Then there is an equilibrium in which the following occurs each h announces [YES] if and only if c h < α h selects z h = 1 iff all agents have announced [YES]  In this equilibrium: agents don’t risk wasted effort if there are genuine high-cost c h agents present that inhibit the project this will be announced at the signalling stage July

Frank Cowell: Signalling Signalling: summary  Both costly and costless signals are important  Costly signals: separating PBE not unique? intuitive criterion suggests out-of-equilibrium beliefs pooling equilibrium may not be unique inconsistent with intuitive criterion?  Costless signals: a role to play in before the game starts July