Principals,Agents,and Moral Hazard
• Moral Hazard: a problem that arise when one person,called
the agent,is performing some task on behalf of another
ex)The employment relationship
– Agent :worker
• Response to the problem
– Better monitoring
– High wages
– Delayed payment
Joseph E. Stiglitz
Adverse selection and the lemon problem
• Adverse selection:a problem that arise in markets in which
the sellers know more about the attributes of the goods
being sold than the buyer does.
– the market for used cars
– labor markets
George Arthur Akerlof
Signaling and Screeng
• Signaling: an action taken by an informed party to reveal
private information to an uninformed party
• Screeing:an action taken by an uniformed party to induce
an informed party to reveal information
– driver's history
– high premiums and low premiums
• public goods(Chap11)
• imperfect competition(Chap15 through17)
• [NEW!]asymmetric information(Chap22)
Markets are are usually good way to organize economic activity.
Governments can sometimes improve market outcomes.
Asymmetric information and Public policy
• The private markets can sometimes deal with information
asymmetries on its own using a combination of signaling
• The government rarely has more information than the
• The government is itself an imperfect institution.
• the study of government using a the analytic
• sometimes called the field of public choice
– the condorect voting paradox
– Arrow's impossibility theorem
– the median voter is King
the condorect voting paradox
• the condorect voting paradox:the failure of majority rule to produce
transitive preference for society
– when there are more than two options,setting agenda can have a
powerful influence over the outcome of a democratic election.
– majority voting by itself does not tell us what a outcome a society
Percent of Electorate
Arrow's impossibility theorem
• Mathematically and incontrovertibly, that no voting
system can satisfy all these following properties.
– Independence of irrelevant alternatives
– No dictators
Kenneth Joseph Arrow
the median voter is King
• Two poritical parties are each trying to maximize their
chance of election,they will both move their positions
toward the median voter.
• Minority views are not given much weight.
People aren't always rational
• People are overconfident.
• People give too much weight to a small number of vivid
• People are reluctant to change their minds.
People care about Fairness
• ultimatum game
– Player A's job is to propose a division of the $100 prize between
himself and the other player.After player A makes his
proposal,player B decides whether to accept or reject it.
• In the language of game theory, the 99-1 spolt is the Nash
• It is more common for player A to propose giving player B an
amount such as $30 or $40.
John Forbes Nash
People are inconsistent over time
1. Would you prefer(A) to spend 50 minutes doing the task
right now or (B) to spend 60 minutes doing the task
2. Would you prefer (A) to spend 50 minutes doing the task in
90 days or (B) to spend 60 minutes doing the task in
An implication of this inconsistency overtime is that people
should try to find ways to commit their future selves to
following through on their plans
• The study of asymmetric information should make you more
wary of market outcome.
• The study of political economy should make you more wary
of government solutions.
• The study of behaviral economics should make yo9u wary of
any institutions that relies on human decision
making,including both the market and the government.