1. C3016:Economics of Information Types of information asymmetry

2. There is only one way that information can be symmetric But there are many ways in which information can be asymmetric The solution given to a problem that exhibits information asymmetry will depend on the type of information asymmetry that is creating the problem A classification will be very useful…

3. Types of information asymmetry There are three basic types of IA:  Moral hazard  Adverse selection  Signalling They differ according to the timing in which the IA takes places

4. Types of information asymmetry Moral hazard  Information is symmetric before the contract is accepted but asymmetric afterwards Two cases of moral hazard:  The agent will carry out a non verifiable action after the signature of the contract (hidden action)  The agent knows the same as the principal before the contract is signed, but it will know more than the principal about an important variable once the contract is accepted (ex post hidden information)

5. Types of information asymmetry Examples of Moral Hazard:  Salesman effort (hidden action)  Effort to drive alert (hidden action)  Effort to diagnose an illness (hidden action)  Whether or not the manager’s strategy is the most appropriate for the market conditions (ex post hidden information)

6. Types of information asymmetry Adverse selection  Information is asymmetric even before the contract is signed  Potentially, there are many types of agents (high ability salesman, low ability salesman), and the principal does not know the type her agent  In other words, the agent can lie to the principal about his type without being punished  Adverse selection is sometimes called ex-ante hidden information  The pure case of Adverse Selection assumes that any action taken by the agent after the contract is accepted can be verified (effort is verifiable)

7. Types of information asymmetry Examples of Adverse Selection  Medical insurance: healthy and unhealthy customers (even if there are tests, they might be too costly)  Highly motivated or low motivated worker  Salesman with a high or low disutility of effort  Drivers that enjoy speed and drivers that dislike speed

8. Types of information asymmetry Signalling  It is like Adverse Selection (there is IA before the signature of the contract) but  Either the P or the A can send a signal to the other that reveals the private information  Of course, the signal has to be credible  Example: A university degree reveals that a potentially employee is smart enough

9. Summary Moral hazard  Information is symmetric before the contract is accepted but asymmetric afterwards Adverse selection  Information is asymmetric before the contract is signed (the P does not know A’s type) Signalling  as AS but sending signals is allowed…