L27 - Information Flashcards
What is Imperfect Information?
: buyer lacks information about prices
- Buyers’ behaviour determines how informed they are
- Lack of information provides firms with market power
What is Asymmetric information?
- one side lacks more information than the other side
- Lack of information determines behaviour
- Markets may only provide low quality goods
What is happen in a market when there is Perfect Information about Prices?
- Two identical firms selling one identical product
- Each product sold costs c to produce and firms set prices
- Two identical consumers want to buy 1 unit –> each values the product at v > c
- Consumers know the prices of both firms
- Consumers are willing to shop at either firm
- considering firm A sells at P{A}=v and firm B sells at P{B}=v –> firm B can easily undercut firm A and take all the demand
- therefore just like bertrands model, they will under cut each other till they are both selling at marginal cost
When all consumers have perfect information, they receive all the benefits from the trade
What is happen in a market when there is imperfect Information about Prices?
- Two identical firms selling one identical product
- Each product sold costs c to produce and firms set prices
- Two identical consumers want to buy 1 unit –> each values the product at v > c
- Consumers DO NOT know the prices of both firms
- Consumers are willing to shop at either firm
- Now consider what prices the firms et if finding information on prices is costly for consumers
- Considering firm A sells at P{A}=c and firm B sells at P{B}=c –> this is not an equilibrium
- if firm A saw that by setting price=MC it makes normal costs, and as buyers dont have complete information, it can raise its prices to make supernormal profits –> thats if the increase in price is so small that the consumer doesnt want to travel to the other firm to check their price
- Firm B will have the same incentive and will slightly increase it higher than firms A
- this will keep happening till both firms charge the price of v –> the consumers willingness to pay
- When all consumers are uniformed about prices and finding out information is costly, they receive none of the benefits from the trade
What is the Unravelling Principle?
- Firms can have incentives to provide information to uninformed consumers
Under certain conditions firms may provide full information - The logic behind this is is known as “the unravelling principle”
What can we infer from the unravelling principle?
Intuition:
- If consumers have no information, they assess all firms as ‘average’
They will purchase from stores at random
- But the firm offering the best terms is better than average
So that firm should disclose this information (so not to be considered average)
It will attract more consumers
When does the Unravelling principle hold?
The unravelling principle holds if:
- there are differences between products which consumers care about
- firms can make costless, credible statements about their products
How do consumer who are informed calculate the average surplus between firms?
- If consumers are uninformed, they will perceive all firms as average where you sum all the consumer surpluses of each firm and divide them by the number of the firms
- However if a firm provides a better surplus than the average –> it better if it reveals that it is above average as it’s profits increase because more consumers will visit
- But now if a firm has revealed that they are above average –> they will now perceive that the other firms are as average –> thus calculate the average surplus of these firms
- then if some of the firms are higher than this average –> then its worth them revealing their information –> this cycle then repeats
Why in most cases do buyers have less information than sellers?
Depends on the good:
- Search goods: easy to assess quality pre-purchase
- Experience goods: difficult to assess quality pre-purchase
- Credence goods: difficult to assess quality pre- & post-purchase
Problems tend to arise for 3. and 2. if bought infrequently
E.g. –> Used cars: salespeople have better information about quality
- they cannot make credible statements (have incentive to lie)
Why in some cases do sellers have less information than buyers?
Lender: borrower has better information than bank about ability to pay back
Insurer: people know whether they park their car in safe area or drive safely
What is the problem of adverse selection?
- High quality products may not be sold to the market
To buy the cars, it costs the firm –> £3000 for a high quality car and £100 for a low quality car - Consumers are willing to pay –> £4000 for a high quality car or £1000 for a low quality car
- The firm could make –> £1000 from selling a high quality car or £900 from selling a low quality car
- But consumers cannot tell which cars are high-quality and which are low quality
- Average willingness to pay is: (4000 + 1000)/2 = £2500
- An uniformed consumer who picks a car at random will be willing to pay £2500
The consumer only willing to pay £2500 - But the salesperson is only willing to sell low quality cars at this price
- The cost to the firm for a high quality car is £3000
The cost to the firm for a low quality car is £100 - The salesperson would make a loss of at least £500 from selling a high quality car!
- Only low-quality cars will be bought and sold: no market for high quality cars!
- The ‘selection’ of cars is ‘adversely’ affected by the asymmetric information
What is the solution to informational Problems?
- In certain situations, a buyers’ and sellers’ strategies may correct the market
1 - Signalling –> make high-quality claim credible - e.g. offer warranty - “If car breaks down, we’ll fix it for free!” –> costly to fix so make sure its high quality
2 - Screening –> buyer get information on firms’ reputation - e.g. from customer reviews, friends, family, - In other situations, there may a role for governments to fix the market
3 - Govt intervention –> minimum standards - verify firms’ claims (checks hygiene levels) - provide information to buyers
