Asymmetric Information

Asymmetric Information is different to the Full Information, that could lead to inefficient situation.

We usually use the Game Theory to make the strategy.

It is in a game with uncertainty, information that one player has but the other does not.

There is a simple setting model called Principal-Agent Model,

One famous example: The Market for Lemons

How to solve (fix) this problem?

• The markets are pretty resilient.
• The sellers would provide some self-fixes that arise: for example

1. Third-party certifications
2. Money-back guarantee
3. Online reviews/comments

• Or provide different kinds of insurance by “screening”. Different menus are offered to attract different types.

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 Above all are all the information about the course [[ECON2003 Intermediate Microeconomics II]], below are the materials about [[ECON4006 Labour Economics]]

Definition of Asymmetric Information

Asymmetric Information is characteristic of many business situations. For example, a seller of product knows more about its quality than buyers does. Workers usually know their own skills better than employers (They know themselves better)

Recall the very classic example: The Market for Lemons

The Principal-Agent Model

Monitoring the productivity of workers is always costly. As the boss of the firm, you can’t observe all the information from your workers.

The objective of owners (boss) is to maximize the profit.

However, the objective of agents (The workers) may not be just maximize profits. Sometimes, managers may pursue their own goals even at the cost of obtaining lower profits for owner.

The Incentives in the principal ---- Agent Framework

Background: Consider a manufacturer uses repairers and machinery to produce watches. The owner wants to maximize profit but the level of profit reply on the effort of repairers and other random factors.

The cost of effort for workers is given by: c = \ 10000 \times a$,here,$a$ is binary, whether 0 or 1.

	Poor Luck	Good Luck
Low Effort $a=0$	10000	20000
High Effort $a=1$	20000	40000

This table shows clearly that there exists a Asymmetric Information problem. The owner will not know whether the repairers have made a low or high effort when revenue = 20,000.

We assume $P(poorluck)=0.5$ and the repairers are risk neutral.

The first useful sheme:

And we set: if Revenue = $10000or$20000, wage=$10000andbonus=0;Revenue=$40000, wage = $10000andbonus=$24000.

• If repairers work hard ($a=1$) :

If good luck: $w=10,000+24,000-1\times 10,000$

If bad luck: $w=10,000+0-1\times 10,000$

The net benefit: $E(NB)=12,000$

• If repairers work low effort ($a=0$)

If good luck: $w=10,000$, $c=0$

$E(NB)=10,000$

The second useful scheme:

We use the wage payment system:

$wage=revenue-18,000$

• If repairers work hard ($a=1$) :

If good luck: $w=40,000-18,000=22,000$

The net benefit: $E(NB)=22,000-1\times 10,000=12,000$

If bad luck: $w=20,000-18,000=2,000$

The net benefit: $E(NB)=2,000-1\times 10,000=-8,000$

$E(NB|a=1)=\frac{12,000-8,000}{2}=2,000$

• If repairers work low effort ($a=0$)

If good luck: $w=20,000-18,000=2,000$

If bad luck: $w=0$ (can’t be less than 0)

The net benefit: $E(NB|a=0)=\frac{2,000+0}{2}=1,000$