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Slide 1 Slide 3
About the Exam
The “Curve” – Score out of 48
Exam Statistics - Average Grade: 80.4%
Econ 410: Micro Theory Two students scored 100% before the curve
The distribution
A’s: 13
Behavioral Economics B’s: 7
C’s: 7
& Asymmetric Information
D’s: 7
Wednesday, October 10th, 2007 F’s: 5
All students with a grade lower than 60%
are required to meet with me to discuss
strategies for how they can improve.
Slide 2 Slide 4
Plan for Today Behavioral Economics
Exam Debrief Sometimes individuals’ behavior
Behavioral Economics contradicts basic assumptions of
consumer choice
What happens when individual behavior
contradicts classic economic assumptions? More information about human behavior
might lead to better understanding
Introduction to Asymmetric Information
This is the objective of behavioral economics
What happens when assumptions about
perfect information are relaxed? Example – Tipping
How can we use economics to study the You take at trip and stop at a restaurant that
market for used cars? you will most likely never stop at again.
Are markets for information different from You still think it fair to leave a 15% tip
other markets? rewarding the good service.
Slide 5 Slide 7
Behavioral Economics Behavioral Economics
Economists assume that consumers place Studying reference points in economics
a unique value on the goods/services tells us that:
purchased Individuals dislike losing things they own
Psychologists have found that perceived People can value items more when they own
value can depend on circumstances them than when they do not
A reference point in behavioral economics Losses are valued more than gains
is the point from which an individual
In this case, the utility loss from selling
makes a consumption decision
the Ben Harper ticket is greater than
Different reference points can have varying original utility gain from purchasing it
impacts on consumer behavior
Slide 6 Slide 8
Behavioral Economics Behavioral Economics
Reference Point Example Other topics in behavioral economics
include:
You are able to buy a ticket to
the sold out Ben Harper concert Experimental Economics
for the published price of $50. Laws of Probability
You find out you can sell the “Fairness”
ticket for $300 but you choose Charitable giving, tipping in restaurants
not to, even though you would
never have paid more than $100 Theory up to now has explained much
for the ticket. but not all of consumer choice
In this case, owning the Ben Although not all of consumer decisions
Harper ticket is the reference can be explained by the theory up to this
point. point, it helps us understand a great deal.
Slide 9 Slide 11
Asymmetric Information Asymmetric Information
What happens in an economic Example – Assume there are 2 types of
transaction when some parties used cars, differentiated by quality
Buyers and sellers can distinguish between
know more than others?
each type of car.
A seller of a good could know more about the 2 distinct markets for the cars exist.
quality of the product than the buyer. In the high quality market, both supply
Managers could know more about costs or and demand are higher than in the low
investment opportunities than firm owners quality market
Owners of high quality cars need more money
Asymmetric information occurs when a
to be willing to sell them
buyer and a seller possess different People are willing to pay more for higher
information about a transaction quality vehicles.
Slide 10 Slide 12
Asymmetric Information Asymmetric Information
The “Lemons” Market • The market price for high
quality cars is $10,000.
Why is a new car worth so much less when PH PL • The market price for low
you drive it off the lot? SH
quality cars is $5000.
•50,000 of each type are sold.
When someone purchases a used car, $10,000
there is a lack of complete information DH
SL
Why is this car being sold?
$5,000
Increases the risk of the purchase
Lowers the value of the car DL
Implications for the used car market 50,000
QH 50,000
QL
Slide 13 Slide 15
Asymmetric Information Asymmetric Information
But, suppose sellers know more about the When asymmetric information exists in a
quality of their used car than potential buyers market:
Buyers can no longer differentiate between Low quality goods can drive high quality
high and low quality cars. goods out of the market - the “lemons”
problem
Suppose that initially buyers think the odds
are 50/50 that the car is high quality The market could fail to produce trades that
are mutually beneficial
Buyers now view all cars as medium quality
with demand DM Adverse Selection
If this is true, prices change such that fewer Occurs when products of different qualities
high quality cars and more low quality cars are sold at a single price
will be sold Lower-quality products can be “adversely
Perceived demand shifts in each market selected” into the market
Slide 14 Slide 16
Asymmetric Information Adverse Selection & Insurance
•But, the increase in QLsell for $7500
Medium quality cars reduces expectations and demand to DLM. Why do older individuals have difficulty
The adjustment process continues until demand = DL.
• At this price, 25,000 high quality and 75,000 low quality are sold.
purchasing health insurance at any price?
PH PL People know more about their health than an
SH insurance company
SL
Because unhealthy people are more likely to want
$10,000
insurance, the proportion of unhealthy people in
$7,500
DH
$7,500 the pool of insured people rises
DM The “adverse selection” of unhealthy
people into the market causes the price
$5,000
DM
DLM
of insurance to rise
DLM DL
Healthy people with low risks of illness drop out
DL
The proportion of unhealthy people rises,
25,000 50,000 QH 50,000 75,000 QL increasing insurance prices even more
Slide 17
Adverse Selection & Insurance
Are males under 25 all bad drivers?
If not, why do they pay so much for car
insurance?
Car insurance companies know that some
males have low probability of getting in an
accident and some have a high probability
Since companies can’t distinguish among
insured, they will base premiums on average
experiences with a particular demographic.
Drivers with low accident risk will choose not
to (fully) insure, which raises the accident
probability and rates
Slide 18
For next time…
We’ll discuss some possible solutions to the
adverse selection problem, and begin to talk
about signaling in markets
Make sure you have read…
Sections 5.5 and 17.1 of your text
Section 17.2
About your exam…
If you have questions about a particular portion
of the exam, please see me during office hours.
Remember that all students with a grade lower
than 60% will be required to meet with me to
discuss how they can improve.
