hat Asymmetric Informatio What happens when individuals have different information? This is called a situation of asymmetric information. The less informed individual is called the principal (P), the more informed is called the agent(A) Economists think about asymmetric information problems using"principal-agent"models. For example, a second-hand car salesman knows the quality of a particular used car, but the buyer does not. The buyer is the principal and the salesman is the agent. Asymmetric information is an important type of market failure. Typically the agent takes a hidden action or has hidden information. The principal tries to learn about the action or information whilst the agent tries to conceal or reveal the action or information. Market- What Nerty dverse selection Nature chooses how good a particular car is. It can be bad or good with equal probability. The principal(buyer) ffers a price. The agent(seller)can either accept or reject this price ○O Contract 200. The principal might thi lly likely for a car to be good or bad. Therefore they might offer a price 600. The agent, howeve the quality of the car. If the car is good, they will not sell it for 600. (It is worth 1000). If it is bad they will sell it, as it is worth 200 Only bad cars will be sold for a price below 1000. The principal knows this and offers a price 200 There is no equilibrium in which good cars are sold. Half the market collapses a serious failure.Market — What Next? 5 Asymmetric Information • What happens when individuals have different information? This is called a situation of asymmetric information. • The less informed individual is called the principal (P), the more informed is called the agent (A). • Economists think about asymmetric information problems using “principal-agent” models. • For example, a second-hand car salesman knows the quality of a particular used car, but the buyer does not. The buyer is the principal and the salesman is the agent. Asymmetric information is an important type of market failure. • Typically the agent takes a hidden action or has hidden information. The principal tries to learn about the action or information whilst the agent tries to conceal or reveal the action or information. • How does a market fail in the presence of asymmetric information? Market — What Next? 6 Adverse Selection • Nature chooses how good a particular car is. It can be bad or good with equal probability. The principal (buyer) offers a price. The agent (seller) can either accept or reject this price. ........................................................................................................................................................ ........................................................................................................................................................ ........................................................................................................................................ ........................................................................................................................................................ ........................................................................................................................................................ . ................................. ... ......... ................. .... . ................................. ... ......... ................. ... . ................................. ... ....... ..................... ... . . . . . . N P A Good Bad Contract Accept Reject • • • • • A good car is worth 1000. A bad car is worth 200. The principal might think it equally likely for a car to be good or bad. Therefore they might offer a price 600. The agent, however, knows the quality of the car. • If the car is good, they will not sell it for 600. (It is worth 1000). If it is bad they will sell it, as it is worth 200. • Only bad cars will be sold for a price below 1000. The principal knows this and offers a price 200. • There is no equilibrium in which good cars are sold. Half the market collapses — a serious failure