hubbard01_instructorppt17.ppt

The Economics of Information,2 of 14,After studying this chapter,you should be able to:Define asymmetric information and distinguish between moral hazard and adverse selection.Apply the concepts of adverse selection and moral hazard to financial markets.Apply the concepts of adverse selection and moral hazard to labor markets.Explain the winners curse and why it occurs.,State Farm Experiences the Hazards of Selling Insurance,LEARNING OBJECTIVES,In the market for insurance,asymmetric information leads to two problems:adverse selection and moral hazard.,3 of 14,Asymmetric Information,Asymmetric information When one party to an economic transaction has less information than the other party.Adverse Selection and the Market for“Lemons”Adverse selection The situation in which one party to a transaction takes advantage of knowing more than the other party to the transaction.,4 of 14,Asymmetric Information,Reducing Adverse Selection in the Car MarketNew cars that need several major repairs during the first year or two after the date of the original purchase may be returned to the manufacturer for a full refund.Car manufacturers must indicate whether a used car they are offering for sale was repurchased from the original owner as a lemon.,5 of 14,Adverse Selection,Annuities,and Social Security Reform,17-1,People who buy annuities live longer than people who dont.,6 of 14,Does Adverse Selection ExplainWhy Some People Do Not Have Health Insurance?,Define asymmetric information and distinguish between adverse selection and moral hazard.,17.1 LEARNING OBJECTIVE,YOUR TURN:Test your understanding by doing related problems 1.10 and 1.11 at the end of this chapter.,Some economists have argued that adverse selection may be an important explanation for the significant percentage of people lacking health insurance in the United States.,7 of 14,Asymmetric Information,Moral HazardMoral hazard The tendency of people who have insurance to change their actions because of the insurance,or,more broadly,actions taken by one party to a transaction that are different than what the other party expected at the time of the transaction.,Dont Confuse Adverse Selection with Moral Hazard,8 of 14,Adverse Selection and Moral Hazard in Financial Markets,Reducing Adverse Selection and Moral Hazard in Financial Markets,Moral Hazard,Big Time:The Accounting Scandals of 2002,17-2,Former Enron Chairman Kenneth Lay was caught up in the accounting scandals of 2002.,9 of 14,Bernard Madoff perpetrated a Ponzi scheme that bilked investors of many billions of dollars.,Moral Hazard,Big Time:Bernie Madoffs“Ponzi”Scheme,YOUR TURN:Test your understanding by doing related problem 2.6 at the end of this chapter.,Apply the concepts of adverse selection and moral hazard to financial markets.,17.2 LEARNING OBJECTIVE,To economists,the lesson of the Madoff case was that to cope with moral hazard,investors need to be sure they understand how their funds are being invested(many of Madoff s investors didnt)and to remember that if the return on an investment seems too good to be true,it probably is.,10 of 14,Adverse Selection and Moral Hazard in Labor Markets,Firms have several ways to make a workers job seem more valuable:Efficiency wages.Seniority system.Profit sharing.,Principal-agent problem A problem caused by an agent pursuing his own interests rather than the interests of the principal who hired him.,Changing Workers Compensation to Reduce Adverse SelectionCompensation that depends on how much workers sell will reduce adverse selection and moral hazard.,17-1,11 of 14,The Winners Curse:When Is It Bad to Win an Auction?,The winners curse The idea that in the winner in certain auctions may have overestimated the value of the good,thus ending up worse off than the losers.,12 of 14,The Winners Curse:When Is It Bad to Win an Auction?,“In competitive bidding,the winner tends to be the player who most overestimates true tract value.”“He who bids on a parcel what he thinks it is worth will,in the long run,be taken to the cleaners.”,17-1,13 of 14,Is There a Winners Curse in the Marriage Market?,17-3,A life of bliss or the winners curse?,Auctions,Available Information,and the Winners CurseWhen the bidders lack full information,the bids are farther apart,and farther from the true value of the item.,17-2,14 of 14,Want to Make Some Money?Try Auctioning a Jar of Coins,17-4,The highest bidder on this jar of coins could lose money.,15 of 14,Hurricane Damage,16 of 14,Bill Would Allow Insurance to Offer Pay-as-You-Drive Plan,Pay Less for Car insurance!(But Well be Watching How You Drive),AN INSIDE LOOK at Policy,Information lowers price and increases quantity in the insurance market.,17 of 14,Adverse selectionAsymmetric informationMoral hazardPrincipal-agent problemWinners curse,