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Asymmetric Information

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.

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Asymmetric Information

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  1. 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.

  2. 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.

  3. 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. • Moral of the story: Sometimes a best deal is one not made.

  4. 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.

  5. More applications:Takeovers • Why do takeovers rarely benefit the companies? • Often the target can benefit from the advantage of the other company: management, size, bringing products to market. • Case study: Chromatis. • Founded by Israelis in 1998. Sold to Lucent in 2000 for $4.8 billion. • Revenue generated for Lucent: • 0. • Lucent closed Chromatis in 2001. • Shortly after for financial reasons Lucent also for the most part dismantled Bell Labs. • Where the transistor, laser, Unix, C, etc. was developed. 6 Nobel prizes for work..

  6. Homework Question • In the takeover game, assume that the value for the seller is uniformly distributed between 50 and 100. • Assume that it is still worth to the buyer 3/2 times the seller’s value. • What should the buyer offer to the seller?

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