Asymmetric Information Asymmetric Information is when parties are

Asymmetric Information • Asymmetric Information is when parties are not equally informed. • For instance, with the sale of a good, the seller may know the value better than the buyer. • In the classroom experiment, the seller (computer) knows how much it is worth, the buyer (student) does not. • The seller is more willing to sell the car if the value is lower than if the value is higher. • Thus, for a given price, a buyer is more likely to attract sellers with lower quality goods.

Buyer-Seller Example • Value for the seller has an equal chance of being any number between 0 and 100. • What is the average value? – 50. • If the buyer offers a price of 50, for which values will the seller sell? – Values 0 to 50. • What is the average of these values? What is 3/2 times the average of these values? – Average 25. This times 3/2 is 37. 5.

General Solution. • If the buyer offers a price of p, for which values will the seller sell. – 0 to p. • What is 3/2 times the average of these values? – Average is p/2. This times 3/2 is (3/4) p. • On average, how much will the buyer make if he values the object 3/2 times the seller. What should the buyer do? – 3/2 * p/2 –p=3/4 p –p= -p/4. Set p=0.

Applications • Akelof recognized this problem in that used cars tend to be lemons. • That is the seller knows more about the condition than the buyer. • This is one reason why as soon as one leaves the dealer with a new car it has a significant drop in value.