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Chapter16AsymmetricInformationIntroductionWewanttoseewhatwillhappenwhensomepartiesknowmorethanothers–asymmetricinformationFrequentlyasellerorproducerknowsmoreaboutthequalityoftheproductthanthebuyerdoesManagersknowmoreaboutcosts,competitivepositionandinvestmentopportunitiesthanfirmownersTheMarketforLemonsAsymmetricinformationisasituationinwhichabuyerandasellerpossessdifferentinformationaboutatransaction◦Thelackofcompleteinformationwhenpurchasingausedcarincreasestheriskofthepurchaseandlowersthevalueofthecar◦Marketsforinsurance,financialcreditandemploymentarealsocharacterizedbyasymmetricinformationaboutproductqualityTheMarketforUsedCarsAssume◦Twokindsofcars–highqualityandlowquality◦High-qualitycarsareworth$2000whilethelow-qualitycars$1000forsellers◦Buyersarewillingtopay$2400forHQcarsand$1200forLQcarsIfbuyersandsellerscandistinguishbetweenthecars◦Therewillbetwomarkets–oneforhighqualityandoneforlowqualityTheMarketforUsedCarsSupposethatsellersknowmoreaboutthequalityoftheusedcarthanthebuyerInitiallybuyersmaythinktheoddsare50/50thatthecarishighquality◦Buyerswillbewillingtopaytheexpectedvalueofthecar◦½*$2400+½*$1200=$1800However,ifthebuyeroffers$1800,onlythelemonswillbeofferedforsaleIfthebuyerwascertainthathewouldgetalemon,thehewouldn’tbewillingtopay$1800TheMarketforUsedCarsTheequilibriumpriceinthismarketwouldhavetobesomewherebetween$1000and$1200Forapriceinthisrange,onlyownersoflemonswouldoffertheircarsforsale,andbuyerswouldtherefore(correctly)expecttogetalemonInthismarket,noneofthehigh-qualitycarsgetsoldandallofthemare“crowdedout”Intheextremecase,thewholemarketmaybemissingTheSourceofMarketFailureThereisanexternalitybetweenthesellersofgoodcarsandbadcarsWhenanindividualdecidestotrytosellabadcar,heaffectsthebuyer’sperceptionofthequalityoftheaveragecaronthemarketThislowersthepricethattheyarewillingtopayfortheaveragecar,andthushurtsthepeoplewhoaretryingtosellgoodcarsItisthisexternalitythatcreatesthemarketfailureTheMarketfor...