Information - chapter 10

Complete information: state of being fully informed about the choices that a person and other relevant economic actors face
Information asymmetry: a condition in which one person knows more than another
- Asymmetric information creates problems because it allows a person who is more informed to achieve goals at the expense of a person who is less informed
- If the incentives of both parties are aligned, then the information asymmetry doesn’t matter

Adverse selection: a state that occurs when buyers and sellers have different information about the quality of a good or the riskiness of a situation; results in failure to complete transactions that would have been possible if both sides had the same information
- As a result, some buyers and sellers fail to complete transactions that would have been possible if both sides had the same information
- Relates to unobserved characteristics of people or goods and it occurs before the two parties have entered an agreement

Agent: a person who carries out a task on someone else’s behalf
Principal: a person who entrusts someone with a task; also, in finance, the original amount borrowed or invested
Moral hazard: the tendency for people to behave in a riskier way or to renege on contracts when they do not face the full consequences of their actions
In contrast to adverse selection, moral hazard has to do with actions
- Happens after the two parties have entered into an agreement
- Generally occurs when a principal entrusts an agent with a task, but cannot observe the agent’s actions, as in the employer-employee relationship

Screening: taking action to reveal private information about someone else
- Examples: interviewing job candidates and checking references when hiring, or offering insurance products that appeal to people with different characteristics
- Works best when there is a way to ensure that the information received is credible since people have an incentive to keep their private information private
Signalling: taking action to reveal one’s own private information
- Examples: certifying a used car, getting a university degree, and dressing for success
- Useful in cases in which the more-informed party would prefer to eliminate the information asymmetry
For a signal to be credible, it must carry some cost or mechanism that makes it inaccessible or unappealing to those it is meant to exclude
- Otherwise everyone will use the signal and it will lose its meaning

The potential to develop a reputation creates an incentive for the more informed party to an exchange to behave in a way that is fair and favourable toward the less-informed party
Because hidden information often reveals itself over time, people who consistently take advantage of a less-informed party will develop a bad reputation and customers will begin to avoid doing business with them
A good reputation is a signal that a business or person has treated partners well in the past

Statistical discrimination: distinguishing between choices by generalizing based on observable characteristics in order to fill in missing information
When specific information is missing, rules of thumb and inferences based on statistical averages can serve as rational decision-making tools
However statistical averages aren’t necessarily accurate in every situation and neither are inferences made using statistical discrimination
- Even if they’re the best option when full information is unavailable

When an information problem is pervasive and has a pronounced negative effect on society, the government will sometimes step in to provide the missing information or require that others reveal private information
The effectiveness of these interventions depends in how well the government’s requirements are enforced and how well people understand the information they receive
In a few cases, the government may mandate participation in a market or program to counter a severe adverse selection problem