econ topic 8

what are the two types of information?

hidden type and hidden actoin

hidden type model

pre-trade asymmetric information (or one agent has to make a choice without knowing relevant information)

hidden action model

post-trade asymmetric information (one agent has to make a choice that’s unobservable to the other party)

signalling

when the seller credibly reveals information about the good they’re selling before the trade (ideally reduces adverse selection)

when are signals credible?

when both agents would NOT choose to imitate the other’s choice

general signaling formula

if the price of the good item MINUS the cost to repair the good item is GREATER THAN the cost of the bad item, it IS worthwhile for sellers to signal

if the price of the good item MINUS the cost to repair the bad item is LESS THAN the cost of the bad item, it IS NOT worthwhile for sellers to pretend it’s good

actuarially fair price

a price for an insurance contract that yields zero profit in the long run

moral hazard

when a person/party has an incentive to take on more risk b/c they won’t have to bear the full cost of that risk

principal agent

principal delegates work/decision-making authority to another party (agent)

incentive contracts

when compensation depends partially on outcome