Managerial Economics

2. Introduction
 Asymmetric is something which is not identical on
both sides of a central line and can also be called as
unsymmetrical.
 Information can be said as knowledge communicated
or received concerning a particular fact or
circumstance.
 Asymmetric Information is a situation where one party
to a transaction i.e. Buyer or seller of a product or
service posses different or less information than the
other party

3. TYPES OF ASYMMETRIC
INFORMATION
One side of the market cannot observe the quality of the good
being produced or sold in the market and known as Hidden
Information Problem and one side of the market cannot observe
the actions of the other side of the markets and known as
Hidden Action Problem.
Asymmetric Information as a market failure
 Market failure happens when there is an inefficient
allocation of goods and services in the free market
 In traditional microeconomics, this is shown as a steady
state disequilibrium in which the quantity supplied does
not equal the quantity demanded.

4. Market For Lemons
 The Market for Lemons was a Research Paper in 1970 written by George
Akerlof, an economist and professor at the University of California,
Berkeley. The problem came from the original example of used cars
that Akerlof used to illustrate the concept of asymmetric information,
as defective used cars are commonly referred to as lemons.
 For Example as referred a” lemon” = bad used car, similarly a “plum” =
good used car. Consumers are willing to pay a high price P(H) for a
good car and a price P(L) for a bad car. Sellers are willing to take a high
reservation price R(H) for a good used car and R(L) for bad used car.
Now suppose the market consists of half good cars and half bad cars
and consumers are willing to pay averages of the prices (i.e. ½ of P(H)
+ ½ of P(L). If the averages of prices is less than the high reservation
price (i.e. ½ of P(H) + ½ of P(L) < R(H)) then no seller of good cars
will bring their cars to market and all the available cars are lemons.
This is a Hidden information Problem because consumers do not know
which cars are good cars and only bad cars will wind up on the market.

16. Adverse Selection
 It is form of market failure where as a result of hidden
information problem, too much of the low-quality
products and too little of high quality products are sold.
 A seller may have better information than a buyer about
products and services being offered, putting the buyer at a
disadvantage in the transaction.
 For example if only people who engage in risky behaviour
buy insurance, there is adverse selection problem and a
company’s managers may more willingly issue shares when
they know the share price is overvalued compared to
the real value
Solution to Adverse Selection: Mandate Purchase,
Signalling

24. Moral Hazards
 Moral Hazard is a Hidden Action Problem in the Asymmetric
information. A moral hazard can arise anytime an agreement is entered
into between two entities. Although an agreement has been reached,
either party may decide to act in a way that skews the agreement.
 In case of insurance a property owner obtains insurance on a property,
the contract is based on the idea that the property owner will avoid
situations that may damage the property.
 The moral hazard exists that the property owner, because of the
availability of the insurance, may be less inclined to protect the
property, since the payment from an insurance company lessens the
burden on the property owner in the case of a disaster. Example-
Drivers engage in more risky driving practices because they are
insured.
 Solution to Moral Hazard: Incentive reward scheme, review system

25. Market Signalling
 Signalling is a way to indicate that your product is of high quality.
Signalling is a solution for one of the main features or causes of market
failure in asymmetric information.
 One of the largest problems sellers face is trying to convince buyers or
potential purchasers that what they are trying to sell is as good as they
claim it is.
 This type of problem is common when the features of whatever is
being sold cannot be easily observed by the buyer.
 When in such situations, sellers may try to do something that shows
they are being honest regarding their description of the product.
That something in the world of economics is known as ‘signalling’.
 Warranties can be the best example for Signalling. The Warranty does
not make the car a high quality car but it just allows the owner to signal
the buyers that the car is of high quality. This is known as Sheepskin
Effect.

26. Principal-Agent Problem
 Principle refers to owner(s) of a company (stockholders) and agents are
the managers of day to day operation of the company.
 The principal-agent problem occurs when a principal delegates an
action to another individual (agent), but the principal does not have
full information about how the agent will behave.
 Secondly, the interests of the principal diverge from that of the agent,
meaning that the outcome is less desirable than the principal expects.
 The principal-agent problem can lead to market failure because the
agent pursues his own self-interest rather than that of the principal and
the business may be run in an inefficient way.
 The Principal-agent problem can also cause adverse selection – poor
choices based on asymmetric information. This is where the agent has
private information before a contract is written. For example, a lazy
worker gets a job because the employer doesn’t know he is lazy.

27. Conclusion
 With Asymmetric information buyers will find it difficult to
determine quality and action of the other party which leads to
market failure in the form of adverse selection and moral hazard
but there are also solutions to the problem like signalling.
Looking it in different way growing asymmetrical information
can bea desired outcome of a market economy. As workers
specialize and become more productive in their fields, they can
provide greater value to workers in other fields. For example, a
stockbroker’s services are less valuable to customers who know
enough to buy and sell their own stocks with confidence
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