Microeconomics for Managers B: Chapter 14 Asymmetric Information

These vocabulary flashcards cover the key concepts of asymmetric information, including adverse selection, moral hazard, and various strategies for managing market failures based on the Chapter 14 lecture notes.

Imperfect information

A situation that occurs when a market party does not know something with certainty about the future, the present, or the past, creating doubt about the correct valuation of a traded good.

Asymmetric information

A condition characterized by unequal information between multiple market parties, often leading to market failure because the least informed party faces imperfect information.

Ex-ante asymmetric information

Asymmetric information that occurs prior to concluding an agreement, such as when a buyer is less informed about the quality of a used car than the seller.

Adverse selection

A market problem caused by ex-ante asymmetric information where high-quality products are driven out of the market by the presence of low-quality products.

Lemons

A term used to describe second-hand cars or products of poor quality.

Peaches

A term used to describe second-hand cars or products of good quality.

Expected value

The maximum willingness to pay for a buyer under asymmetric information, calculated by weighting the values of possible outcomes by their probabilities, e.g., $0.5 \times 6000 + 0.5 \times 3000 = €4500$.

Ex-post asymmetric information

Asymmetric information that arises after a contract has been concluded, often related to hidden actions of one of the parties.

Moral hazard

The risk that one party tries to improve its own situation through inappropriate behavior, hidden actions, or lack of precautions after a contract is signed.

Principal-agent problem

A conflict within firms where owners (principals) want maximum profit but cannot directly observe the actions and efforts of employees or managers (agents).

Direct screening

The acquisition of additional information by the least informed party to restore information symmetry, such as having a second-hand car examined by an expert.

Selection (Indirect screening)

The acquisition of information by the least informed party through the self-selection choices made by the other party, such as a mandatory medical test for life insurance.

Signaling

The provision of additional information by the best-informed market party to convince the less-informed party, such as offering a warranty or possessing an educational diploma.

Co-payment (Results-related payment)

A form of signaling where the seller agrees to be paid based on the actual yields or performance of the product, such as resale clauses in football transfers.

Monitoring and verification

Methods used to manage moral hazard by checking the information provided by the agent or detecting hidden actions using tools like cameras or mandatory fire detectors.

Bonus-malus system

An incentive-based system for insurance premiums where 'bad' drivers pay higher premiums and 'good' drivers receive discounts.

Franchise

A form of co-payment in insurance where the insured party pays part of the costs themselves to reduce the risk of moral hazard.

Incentives

Rewards such as performance-related salaries, bonuses, or stock options designed to align the interests of the agent with those of the principal.