Final

Question 1

In general terms, what is adverse selection?

Answer 1

Situation where only constant-price contracts are offered and the informed party decides to participate upon observation. Job market/unraveling.

Question 2

In general terms, what is cheap talk?

Answer 2

Costless messages or actions are sent from the informed party to the uninformed.

Question 3

In general terms, what is screening/NLP?

Answer 3

The uninformed side offers a menu to the informed party. Used in airline prices.

Question 4

In general terms, what is mechanism design?

Answer 4

Similar to screening, but more complicated forms of moving the informed party to a particular outcome. Often utilize auctions or public good valuations.

Question 5

In cheap talk, what does a lower value for “b” mean?

Answer 5

Preferences between sender/receiver are more closely aligned

Question 6

What is each party trying to accomplish in cheap talk?

Answer 6

Minimize their loss function:

1. Sender = L(l y - b - θ l)
2. Receiver = L(l y - θ l)

Question 7

What are the results of the cheap talk model?

Answer 7

1. No PBE where sender gives message m = θ
2. The difference in length between two adjacent intervals is 4b.
3. There is always a babbling equilibrium where one interval/partition exists
4. The number of partitions is decreasing in b.

Question 8

What is the most efficient equilibrium in a cheap talk model?

Answer 8

Where the number of intervals is maximized

nx+2bn(n-1) = 1

Question 9

How can the relationship between “b” and “n” be explained?

Answer 9

b < 1/2n(n-1)

Question 10

How do you construct partitions/intervals in the cheap talk model?

Answer 10

1. Set nx+2bn(n-1) = 1
2. Solve for “n”, plug in to solve for “x”
3. Use to solve for intervals

Question 11

How do you calculate the expected utility for the receiver/sender in cheap talk?

Answer 11

1. Find the area under the curve by taking the integral of the partitions
2. If loss function is absolute value, have to split babbling into parts to keep values positive
   * *For instance, ∫(1/2 - x)dx + ∫(x - 1/2)dx
3. Sum of welfare should be negative since there is loss

Question 12

How do you find the Pareto dominant equilibrium in cheap talk?

Answer 12

1. Maximize the number of partitions given “x”
2. Plug back in and solve for “x”
3. Use to determine interval lengths

Question 13

How do you find the values of “b” where the only equilibrium is a babbling one?

Answer 13

1. Plug n = 2 into nx+2bn(n-1) > 1
2. Solve for “b”
3. Plug in “x” almost equal to 0

Question 14

If one or neither party can send a signal and there is a uniform offer presented to all market participants, which model are you dealing with?

Answer 14

Adverse selection

Question 15

What is the Pareto efficient allocation in adverse selection?

Answer 15

The full information case

Question 16

How do you find the equilibrium in adverse selection when information is asymmetric?

Answer 16

1. Find w* = E[θl r(θ) ≤ w*]
2. Max. the profit function (by solving for θ in terms of w. Plug back into expectation
   * *Be sure to subtract all costs, whether wage or fixed if not already accounted for in the profit function).

Question 17

How do you calculate the expected output given a w in adverse selection?

Answer 17

1. Find the range of θ that satisfies r(θ) ≤ w
   a) If uniform, E[θ] = midpoint –> a+b/2
   b) If not, E[θl a ≤ θ ≤ b] = ∫ θ * f(θ)/F(b) - F(a)

Question 18

What are the main assumptions of adverse selection?

Answer 18

1. Multiple principals competing for agents
2. The agent has a privately known type
3. r(θ) is the type-dependent outside option (reservation)

Question 19

What is the first-best solution in adverse selection?

Answer 19

1. SPE where w*(θ) = θ

Question 20

What is the second-best solution in adverse selection?

Answer 20

1. PBE where r’(θ) > 0 and r(θ) < θ for both types
2. w* = E[θl r(θ) ≤ w*]
3. Equilibrium wage is increasing in θ

Question 21

Why can’t the government produce better outcomes in the adverse selection model?

Answer 21

It is assumed that they do not have better information than the principals/agents

Question 22

What are the assumptions of screening/NLP?

Answer 22

1. Principal is uninformed, but sets terms of the exchange
2. There are multiple types of agents
3. Agents have different utilities w/ single-crossing property (high types willing to pay more for an additional unit).

Question 23

What is the sequence of events in NLP?

Answer 23

1. Agent privately observes θ
2. Principal offers a menu {q, T}
3. Agent accepts/rejects and outcomes are realized

Question 24

What happens in the full info. NLP model?

Answer 24

Principal sets a binding IR (perfect price discrimination) by finding max. utility for the agent

Question 25

What are the steps in the asymmetric NLP model?

Answer 25

1. Set up an IR/IC for each type 2. Eliminate IR by proving that IR for one type > IR for the other (**focus on types, not qty.) 3. Eliminate IC to form another condition. If this condition binds, the other IC is implied 4. Check which binding IC max. principal's profit

Question 26

What are the assumptions of moral hazard?

Answer 26

1. There is uncertainty/risk that one party is attempting to transfer to the other 2. Contracting is made over outcomes since effort is not observable or unverifiable

Question 27

What is the first-best solution for moral hazard?

Answer 27

To offer a fixed contract i.e. "sell the firm" to the agent

Question 28

What is the second-best solution for moral hazard?

Answer 28

To utilize the sharing rule. This rule changes depending on whether the agent is risk-neutral or risk-averse (know both formulas)

Question 29

What are the features of the BDM model?

Answer 29

1. Agent has a valuation θ, but can lie about the value 2. It is a weakly dominant strategy for the agent to be truthful 3. Random price (auction)

Question 30

What are the features of the GCM model?

Answer 30

1. Concerned w/ pivotal agents and externalities (public goods) 2. Price is determined by pivotal agents

Question 31

What are the conditions of the GRET model?

Answer 31

1. Expected utility for the lowest type is the same | 2. Expected consumption of each type is the same (same expected revenue for principal).