Class 2 -Asymmetric Information

Perfect market assumptions: Large number of buyers and sellers, Homogeneous products (quality), No discrimination, Perfect knowledge, No barriers to entry or exit, Capital mobility, Utility maximization, No transaction costs

Asymmetric Information: Parties on opposite side of a transaction have different amounts of

economically relevant information, producing economic inefficiency.

• example: a managers job is to keep stakeholders aware of what is going on in the company or else the stakeholders will sell.

• occurs in insurance, credit, & captial markets

• Comes in two forms: Adverse Selection & Moral Hazard

  • Adverse Selection: before transaction occurs,

  • Moral Hazard: after transaction occurs,

• Two ways to mitigate asymmetric information: Screening & Signaling

  • Screening: ignorant party determines types of people, very costly. (ex. Banks doing credit checks)

  • Signaling: knowledgable party signals quality (ex. guarantees attached to products)

• Conflicts of Interest: institution/person has multiple interests and serves one at the expense of another