Downloaded 22 times
More Related Content
Price vs quality
- 1. Asymmetric Pricing: High Cost= Quality or Quality= High Cost
- 2. Problems Due toAsymmetric Information adverse selection - opportunism characterized by an informed person’s benefiting from trading or otherwise contracting with a less-informed person who does not know about an unobserved characteristic of the informed person
- 3. Problems Due toAsymmetric Information moral hazard - opportunism characterized by an informed person’s taking advantage of a less informed person through an unobserved action
- 4. Controlling Opportunistic Behavior ThroughUniversal Coverage Adverse selection can be prevented if informed people have no choice. A government can avoid adverse selection by providing insurance to everyone or by mandating that everyone buy insurance.
- 5. Equalizing Information screening- an action taken by an uninformed person to determine the information possessed by informed people. signaling - an action taken by an informed person to send information to an uninformed person.
- 6. Lemons Market withFixed Quality When buyers cannot judge a product’s quality before purchasing it, low-quality products—lemons—may drive high- quality products out of the market.
- 7. Lemons Market withFixed Quality Cars that appear to be identical on the outside often differ substantially in the number of repairs they will need. Some cars —lemons— have a variety of insidious problems that become apparent to the owner only after the car has been driven for a while. The seller of a used car knows from experience whether the car is a lemon. We assume that the seller cannot alter the quality of the used car
- 8. Lemons Market withFixed Quality Suppose that there are many potential buyers for used cars. All are willing to pay $1,000 for a lemon and $2,000 for a good used car.
- 9. Markets for Lemonsand Good Cars (a) Ma rket f r Lemons o (b) Ma rket or Good Cars f Prce of a good ca r, $ Prce of a lemon, $ 2,000 DG i i 1,000 DL 0 0 Lemons per year Good cars per year
- 10. Lemons Market withFixed Quality 1,000 owners of lemons and 1,000 owners of good cars are willing to sell. The reservation price of owners of lemons— the lowest price at which they will sell their cars—is $750. The reservation price of owners of high- quality used cars is v, which is less than $2,000.
- 11. Markets for Lemonsand Good Cars (a) Ma rket f r Lemons o (b) Ma rket or Good Cars f Prce of a good ca r, $ Prce of a lemon, $ SL E 2,000 DG 1,750 i f S2 F i 1,500 D* 1,500 D* 1,250 e S1 1,000 DL 750 0 1,000 0 1,000 Lemons per year Good cars per year
- 12. Lemons Market withFixed Quality If both sellers and buyers know the quality of all the used cars before any sales take place, all the cars are sold, and good cars sell for more than lemons. This market is efficient because the goods go to the people who value them the most. All the cars are sold if everyone has the same information
- 13. Lemons Market withFixed Quality The amount of information they have affects the price at which the cars sell. If no one can tell a lemon from a good car at the time of purchase, both types of cars sell for the same price.
- 14. Lemons Market withFixed Quality Suppose that everyone is risk neutral and no one can identify the lemons: Buyers and sellers are equally ignorant. A buyer has an equal chance of buying a lemon or a good car. The expected value of a used car is
- 15. Lemons Market withFixed Quality This market is efficient because the cars go to people who value them more than their original owners. Sellers of good-quality cars are implicitly subsidizing sellers of lemons.
- 16. Asymmetric Information. Ifsellers know the quality but buyers do not, this market may be inefficient: The better-quality cars may not be sold even though buyers value good cars more than sellers do. The equilibrium in this market depends on whether the value that the owners of good cars place on their cars, v, is greater or less than the expected value of buyers, $1,500.
- 17. Figure 19.1 Marketsfor Lemons and Good Cars (a) Ma rket f r Lemons o (b) Ma rket or Good Cars f Prce of a good ca r, $ Prce of a lemon, $ SL E 2,000 DG 1,750 i f S2 F i 1,500 D* 1,500 D* 1,250 e S1 1,000 DL 750 0 1,000 0 1,000 Lemons per year Good cars per year
- 18. Asymmetric Information. Consequently,asymmetric information does not cause an efficiency problem, but it does have equity implications. Sellers of lemons benefit and sellers of good cars suffer from consumers’ inability to distinguish quality.
- 19. Asymmetric Information. Nowsuppose that the sellers of good cars place a value of v = $1,750 on their cars and thus are unwilling to sell them for $1,500. As a result, the lemons drive good cars out of the market. Buyers realize that, at any price less than $1,750, they can buy only lemons. Consequently, in equilibrium, the 1,000 lemons sell for the expected (and actual) price of $1,000, and no good cars change hands.
- 20. Asymmetric Information. Thisequilibrium is inefficient because high-quality cars remain in the hands of people who value them less than potential buyers do.
- 21. Lemons Market withVariable Quality Suppose that it costs $10 to produce a low- quality book bag and $20 to produce a high- quality bag, consumers cannot distinguish between the products before purchase, there are no repeat purchases, and consumers value the bags at their cost of production. The five firms in the market produce 100 bags each. A firm produces only high-quality or only low- quality bags.
- 22. Lemons Market withVariable Quality If one firm makes a high-quality bag and all the others make low-quality bags, the expected value per bag to consumers is Thus, if one firm raises the quality of its product, all firms benefit because the bags sell for $12 instead of $10.
- 23. Lemons Market withVariable Quality Because the high-quality firm incurs all the expenses of raising quality, $10 extra per bag, and reaps only a fraction, $2, of the benefits, it opts not to produce the high-quality bags. Therefore, due to asymmetric information, the firms do not produce high-quality goods even though consumers are willing to pay for the extra quality.
- 24. Limiting Lemons Laws to Prevent Opportunism. Consumer Screening. Third-Party Comparisons. Standards and Certification. Signaling by Firms.
- 25. Price Discrimination Dueto False Beliefs About Quality One way in which firms confuse consumers is to create noise by selling virtually the same product under various brand names.
- 26. Market Power fromPrice Ignorance Suppose that many stores in a town sell the same good. If consumers have full information about prices, all stores charge the full-information competitive price, p*. If one store were to raise its price above p*, the store would lose all its business. Each store faces a residual demand curve that is horizontal at the going market price and has no market power.
- 27. Market Power fromPrice Ignorance If consumers have limited information about the price that firms charge for a product, one store can charge more than others and not lose all its customers. Customers who do not know that the product is available for less elsewhere keep buying from the high-price store. Thus, each store faces a downward-sloping residual demand curve and has some market power.
- 28. Tourist-Trap Model Youarrive in a small town near the site of the discovery of gold in California. Souvenir shops crowd the street. Wandering by one of these stores, you see that it sells the town’s distinctive snowy: a plastic ball filled with water and imitation snow featuring a model of the Donner Party. You instantly decide that you must buy at least one of these tasteful mementos— perhaps more if the price is low enough. Your bus will leave very soon, so you can’t check the price at each shop to find the lowest price. Moreover, determining which shop has the lowest price won’t be useful to you in the future because you do not intend to return anytime soon.
- 29. Tourist-Trap Model Let’sassume that you and other tourists have a guidebook that reports how many souvenir shops charge each possible price for the snowy, but the guidebook does not state the price at any particular shop. There are many tourists in your position, each with an identical demand function.
- 30. Tourist-Trap Model Itcosts each tourist c in time and expenses to visit a shop to check the price or buy a snowy. Thus, if the price is p, the cost of buying a snowy at the first shop you visit is p + c. If you go to two souvenir shops before buying at the second shop, the cost of the snowy is p + 2c.
- 31. When Price IsNot Competitive. Will all souvenir shops charge the same price? If so, what price will they charge?
- 32. When Price IsNot Competitive. If all other shops charge p*, a firm can profitably charge p1 = p* + ε, where ε, a small positive number, is the shop’s price markup. If consumers have limited information about price, an equilibrium in which all firms charge the full-information, competitive price is impossible.
- 33. Monopoly Price. Canthere be an equilibrium in which all stores charge the same price and that price is higher than the competitive price? The monopoly price may be an equilibrium price.
- 34. Monopoly Price. When consumers have asymmetric information and when search costs and the number of firms are large, the only possible single-price equilibrium is at the monopoly price.