Ch17 MARKETS WITH ASYMMETRIC INFORMATION.doc

CHAPTER 17
MARKETS WITH ASYMMETRIC INFORMATION
TEACHING NOTES
This chapter explores different situations in which one party knows more than the other, or in other words, what happens when there is asymmetric information. Section discusses the case where the seller has more information than the buyer, and section discusses market signaling as a mechanism to deal with the problem of asymmetric information. Section discusses the moral hazard problem where one party has more information about their behavior than does the other party. Section discusses the principal agent problem and section extends the analysis to the case of an integrated firm. Both sections address the issue of differing goals between owners and managers. Section examines the efficiency wage theory. There are basically four topics that the instructor can pick and choose between depending on time constraints and general interest.
It is best to introduce asymmetric information by reviewing the cases where microeconomics has assumed perfect information. For example, except for Chapter 5 and sections of Chapter 15, we have assumed perfect knowledge of the future (no uncertainty). In models of uncertainty, consumers and producers play “games against nature.” In models of asymmetric information, they are playing games with each other.
Many of your students are likely to have bought or sold a used car and will, therefore, find the lemons model interesting. Start your presentation by asking the sellers of used cars how they determined their asking price. Emphasize the intuition of the model before presenting Figure . If they have understood the model, they should ask a high price to give the impression to buyers that the car they are selling is of high quality. Class discussion could consider whether the government should pass laws requiring warranties in the sale of used cars.
The market for insurance is also one with which most students are familiar. Although car