第 17 章信息不对称的市场
Chapter 17 Slide 2
本章要讨论的问题质量不确定性与柠檬市场市场信号道德风险委托代理问题
Chapter 17 Slide 3
本章要讨论的问题一体化企业的管理激励问题劳动力市场的信息不对称,效率工资理论
Chapter 17 Slide 4
引言我们将研究不完全信息对资源配置和价格机制所产生的影响。
Chapter 17 Slide 5
质量不确定与柠檬市场在购买一辆二手车时，由于信息不完全，将增加购买的风险并降低消费者的效用；
Chapter 17 Slide 6
二手车市场
假定
买卖双方都能鉴别高质量和低质量的车；
将会出现两个市场；
质量不确定与柠檬市场柠檬问题
PH PL
QH QL
SH
SL
DH
DL
5,000
50,000 50,000
买卖双方能鉴别车的质量时，
将出现高质量和低质量两个市场
10,000
DL
DM
DM
75,00025,000
由于信息不对称，消费者无法确定车的质量，他们将降低对二手车质量的期望 。 Demand for low and high quality
used cars shifts to DM.
DLM
DLM
The increase in QL
reduces expectations and
demand to DLM,The adjustment process
continues until demand = DL.
Chapter 17 Slide 8
The Market for Used Cars
With asymmetric information:
Low quality goods drive high quality goods
out of the market.
The market has failed to produce mutually
beneficial trade.
Too many low and too few high quality cars
are on the market.
Adverse selection occurs; the only cars on
the market will be low quality cars.
Quality Uncertainty
and the Market for Lemons
Chapter 17 Slide 9
Implications of Asymmetric Information
Medical Insurance
Question
Is it possible for insurance companies to
separate high and low risk policy holders?
If not,only high risk people will purchase
insurance.
Adverse selection would make medical
insurance unprofitable.
The Market for Insurance
Chapter 17 Slide 10
Implications of Asymmetric Information
Automobile Insurance
Questions
What impact does asymmetric information
and adverse selection have on insurance
rates and the delivery of automobile accident
insurance?
How can the government reduce the impact
of adverse selection in the insurance
industry?
The Market for Insurance
Chapter 17 Slide 11
Implications of Asymmetric Information
The Market for Credit
Asymmetric information creates the
potential that only high risk borrowers
will seek loans.
Question
How can credit histories help make
this market more efficient and reduce
the cost of credit?
Chapter 17 Slide 12
Implications of Asymmetric Information
The Importance of Reputation and
Standardization
Asymmetric Information and Daily
Market Decisions
Retail sales
Antiques,art,rare coins
Home repairs
Restaurants
Chapter 17 Slide 13
Implications of Asymmetric Information
Question
How can these producers provide high-
quality goods when asymmetric
information will drive out high-quality
goods through adverse selection.
Answer
Reputation
Chapter 17 Slide 14
Implications of Asymmetric Information
Question
Why do you look forward to a Big Mac
when traveling even though you would
never consider buying one at home.
Holiday Inn once advertised,No Surprises” to
address the issue of adverse selection.
Chapter 17 Slide 15
Lemons in Major League Baseball
Asymmetric information and the market for
free agents
If a lemons market exists,free agents
should be less reliable (disabled) than
renewed contracts.
Chapter 17 Slide 16
Player Disability
All Players 4.73 12.55 165.4
Renewed players 4.76 9.68 103.4
Free agents 4.67 17.23 268.9
Days Spent on Disabled List per Season
Precontract Postcontract Percentage Change
Chapter 17 Slide 17
Findings
Days on the disabled list increase for
both free agents and renewed players.
Free agents have a significantly higher
disability rate than renewed players.
This indicates a lemons market.
Lemons in Major League Baseball
Chapter 17 Slide 18
Question
If you are a team owner,what steps
would you take to reduce the
asymmetric information for free agents?
Lemons in Major League Baseball
Chapter 17 Slide 19
Market Signaling
The process of sellers using signals to
convey information to buyers about the
product’s quality helps buyers and sellers
deal with asymmetric information.
Chapter 17 Slide 20
Market Signaling
Strong Signal
To be effective,a signal must be easier
for high quality sellers to give than low
quality sellers.
Example
Highly productive workers signal with
educational attainment level,
Chapter 17 Slide 21
Market Signaling
A Simple Model of Job Market Signaling
Assume
Two groups of workers
Group I,Low productivity--AP & MP = 1
Group II,High productivity--AP & MP = 2
The workers are equally divided between
Group I and Group II--AP for all workers
= 1.5
Chapter 17 Slide 22
Market Signaling
A Simple Model of Job Market Signaling
Assume
Competitive Product Market
P = $10,000
Employees average 10 years of
employment
Group I Revenue = $100,000 (10,000/yr,
x 10)
Group II Revenue = $200,000 (20,000/yr,
X 10)
Chapter 17 Slide 23
Market Signaling
With Complete Information
w = MRP
Group I wage = $10,000/yr.
Group II wage = $20,000/yr.
With Asymmetric Information
w = average productivity
Group I & II wage = $15,000
Chapter 17 Slide 24
Market Signaling
Signaling With Education to Reduce
Asymmetric Information
y = education index (years of higher
education)
C = cost of attaining educational level y
Group I--CI(y) = $40,000y
Group II--CII(y) = $20,000y
Chapter 17 Slide 25
Market Signaling
Signaling With Education to Reduce
Asymmetric Information
Assume education does not increase
productivity
Decision Rule:
y* signals GII and wage = $20,000
Below y* signals GI and wage =
$10,000
Signaling
Years of
College
Value of
College
Educ.
0
$100K
Value of
College
Educ.
Years of
College
1 2 3 4 5 6 0 1 2 3 4 5 6
$200K
$100K
$200K
Group I Group II
CI(y) = $40,000y
Optimal choice of
y for Group I
How much education
should a person obtain?
The education decision
is based on benefits/cost
comparison.
B(y) B(y)
y* y*
B(y) = increase in
wage associated with
each level of education
CII(y) = $20,000y
Optimal choice of
y for Group I
Signaling
Years of
College
Value of
College
Educ.
0
$100K
Value of
College
Educ.
Years of
College
1 2 3 4 5 6 0 1 2 3 4 5 6
$200K
$100K
$200KC
I(y) = $40,000y
Optimal choice of
y for Group I
B(y) B(y)
y* y*
Benefits = $100,000
Cost
CI(y) = 40,000y
$100,000<$40,000y*
y* > 2.5
Choose no education
CII(y) = $20,000y
Optimal choice of
y for Group I
Benefits = $100,000
Cost
CII(yO)= 20,000y
$100,000<$20,000y*
y* < 5
Choose y*
Chapter 17 Slide 28
Signaling
Cost/Benefit Comparison
Decision rule works if y* is between 2.5
and 5
If y* = 4
Group I would choose no school
Group II would choose y*
Rule discriminates correctly
Chapter 17 Slide 29
Signaling
Education does increase productivity and
provides a useful signal about individual
work habits.
Chapter 17 Slide 30
Working into the Night
Question
How can you signal to your employer
you are more productive?
Chapter 17 Slide 31
Market Signaling
Guarantees and Warranties
Signaling to identify high quality and
dependability
Effective decision tool because the cost
of warranties to low-quality producers is
too high
Chapter 17 Slide 32
Moral Hazard
Moral hazard occurs when the insured party
whose actions are unobserved can affect
the probability or magnitude of a payment
associated with an event.
Chapter 17 Slide 33
Moral Hazard
Determining the Premium for Fire Insurance
Warehouse worth $100,000
Probability of a fire:
.005 with a $50 fire prevention
program
.01 without the program
Chapter 17 Slide 34
Moral Hazard
Determining the Premium for Fire Insurance
With the program the premium is:
,005 x $100,000 = $500
Once insured owners purchase the insurance,the
owners no longer have an incentive to run the
program,therefore the probability of loss is,01
$500 premium will lead to a loss because the
expected loss is not $1,000 (.01 x $100,000)
Chapter 17 Slide 35
The Effects of Moral Hazard
Miles per Week0
$0.50
50 100 140
Cost
per
Mile
$1.00
$1.50
$2.00
D = MB
MC’
With moral hazard
insurance companies cannot
measure mileage,MC to $1.00 and
miles driven increases to 140
miles/week--inefficient allocation.
MC
MC is the marginal cost
of driving,With no moral hazard
and assuming insurance
companies can measure miles
driven MC = MB at $1.50 and
100 miles/week--efficient allocation.
Chapter 17 Slide 36
Reducing Moral Hazard
--Warranties of Animal Health
Scenario
Livestock buyers want disease free animals.
Asymmetric information exists
Many states require warranties
Buyers and sellers no longer have an incentive
to reduce disease (moral hazard).
Question
How can this moral hazard be reduced?
Chapter 17 Slide 37
Crisis in the Savings and Loan Industry
Question
How many people know the financial
strength of their bank?
Why not?
Deposit insurance,moral hazard,and
failures in the S&L industry
Chapter 17 Slide 38
Cost of the S&L Bailout
1,000+ failed institutions
$200 billion (1990)
Texas alone--$42 billion (1990)
Agency expenditures--$100 million (1990)
Question
How can this moral hazard be reduced?
Crisis in the Savings and Loan Industry
Chapter 17 Slide 39
The Principal--Agent Problem
Agency Relationship
One person’s welfare depends on what
another person does
Agent
Person who acts
Principal
Person whom the action effects
Chapter 17 Slide 40
The Principal--Agent Problem
Company owners are principals.
Workers and managers are agents.
Owners do not have complete knowledge.
Employees may pursue their own goals and
reduce profits.
Chapter 17 Slide 41
The Principal--Agent Problem
The Principal--Agent Problem in Private
Enterprises
Only 16 of 100 largest corporations have
individual family or financial institution
ownership exceeding 10%.
Most large firms are controlled by
management.
Monitoring management is costly
(asymmetric information).
Chapter 17 Slide 42
The Principal--Agent Problem
The Principal--Agent Problem in Private
Enterprises
Managers may pursue their own
objectives.
Growth
Utility from job
Chapter 17 Slide 43
The Principal--Agent Problem
The Principal--Agent Problem in Private
Enterprises
Limitations to managers’ ability to
deviate from objective of owners
Stockholders can oust managers
Takeover attempts
Market for managers who maximize
profits
Chapter 17 Slide 44
The Principal--Agent Problem
The Principal--Agent Problem in Public
Enterprises
Observations
Managers’ goals may deviate from the
agencies goal (size)
Oversight is difficult (asymmetric
information)
Market forces are lacking
Chapter 17 Slide 45
The Principal--Agent Problem
The Principal--Agent Problem in Public Enterprises
Limitations to Management Power
Managers choose a public service position
Managerial job market
Legislative and agency oversight (GAO &
OMB)
Competition among agencies
Chapter 17 Slide 46
The Managers of
Nonprofit Hospitals as Agents
Are non profit organizations more or less
efficient that for-profit firms?
725 hospitals from 14 hospital chains
Return on investment (ROI) and average
cost (AC) measured
Chapter 17 Slide 47
For-Profit 11.6% 12.7%
Nonprofit 8.8% 7.4%
Return On Investment
1977 1981
The Managers of
Nonprofit Hospitals as Agents
Chapter 17 Slide 48
After adjusting for differences in services:
AC/patient day in nonprofits is 8%
greater than profits
Conclusion
Profit incentive impacts performance
Cost and benefits of subsidizing
nonprofits must be considered.
The Managers of
Nonprofit Hospitals as Agents
Chapter 17 Slide 49
Incentives in the Principal-Agent Framework
Designing a reward system to align the
principal and agent’s goals--an example
Watch manufacturer
Uses labor and machinery
Owners goal is to maximize profit
Machine repairperson can influence
reliability of machines and profits
The Managers of
Nonprofit Hospitals as Agents
Chapter 17 Slide 50
The Principal--Agent Problem
Incentives in the Principal-Agent Framework
Designing a reward system to align the
principal and agent’s goals--an example
Revenue also depends,in part,on the
quality of parts and the reliability of labor.
High monitoring cost makes it difficult to
assess the repair-person’s work
Chapter 17 Slide 51
The Revenue from Making Watches
Low effort (a = 0) $10,000 $20,000
High effort (a = 1) $20,000 $40,000
Poor Luck Good Luck
Chapter 17 Slide 52
The Principal--Agent Problem
Incentives in the Principal-Agent Framework
Designing a reward system to align the principal and
agent’s goals--an example
Repairperson can work with either high or low
effort
Revenues depend on effort relative to the other
events (poor or good luck)
Owners cannot determine a high or low effort
when revenue = $20,000
Chapter 17 Slide 53
The Principal--Agent Problem
Incentives in the Principal-Agent Framework
Designing a reward system to align the principal and
agent’s goals--an example
Repairperson’s goal is to maximize wage net of
cost
Cost = 0 for low effort
Cost = $10,000 for high effort
w(R) = repairperson wage based only on output
Chapter 17 Slide 54
The Principal--Agent Problem
Incentives in the Principal-Agent Framework
Choosing a Wage
w = 0; a = 0; R = $15,000
R = $10,000 or $20,000,w = 0
R = $40,000; w = $24,000
R = $30,000; Profit = $18,000
Net wage = $2,000
Chapter 17 Slide 55
The Principal--Agent Problem
Incentives in the Principal-Agent Framework
Choosing a Wage
w = R - $18,000
Net wage = $2,000
High effort
Chapter 17 Slide 56
The Principal--Agent Problem
Conclusion
Incentive structure that rewards the
outcome of high levels of effort can
induce agents to aim for the goals set by
the principals.
Chapter 17 Slide 57
The Principal--Agent Problem
Asymmetric Information and Incentive Design in
the Integrated Firm
In integrated firms,division managers have
better (asymmetric) information about
production than central management
Chapter 17 Slide 58
The Principal--Agent Problem
Asymmetric Information and Incentive Design in
the Integrated Firm
Two Issues
How can central management illicit
accurate information
How can central management achieve
efficient divisional production
Chapter 17 Slide 59
The Principal--Agent Problem
Possible Incentive Plans
Bonus based on output or profit
Will this plan provide an incentive for
accurate information?
Chapter 17 Slide 60
The Principal--Agent Problem
Possible Incentive Plans
Bonus based on how close the managers
get to their forecasts of output and profits
Qf = estimate of feasible production level
B = bonus in dollars
Q = actual output
B = 10,000 -,5(Qf - Q)
Incentive to underestimate Qf
Chapter 17 Slide 61
The Principal--Agent Problem
Possible Incentive Plans
Bonus still tied to accuracy of forecast
If Q > Qf ;B =,3Qf +,2(Q - Qf)
If Q < Qf ;B =,3Qf -,5(Qf - Q)
Chapter 17 Slide 62
Incentive Design in an Integrated Firm
Output
(units per year)
2,000
4,000
6,000
10,000
0 10,000 20,000 30,000 40,000
Bonus
($ per
year)
8,000
If Qf = 30,000,
bonus is $6,000,
the maximum
amount possible.
Qf = 30,000
Qf = 10,000
If Qf = 10,000,
bonus is $5,000
Qf = 20,000
If Qf = 20,000,
bonus is $4,000
Chapter 17 Slide 63
Asymmetric Information in Labor Markets,Efficiency
Wage Theory
In a competitive labor market,all who wish to
work will find jobs for a wage equal to their
marginal product.
However,most countries’ economies
experience unemployment.
Chapter 17 Slide 64
The efficiency wage theory can explain the
presence of unemployment and wage
discrimination.
In developing countries,productivity
depends on the wage rate for nutritional
reasons.
Asymmetric Information in Labor Markets,Efficiency
Wage Theory
Chapter 17 Slide 65
The shirking model can be better used to
explain unemployment and wage
discrimination in the United States.
Assumes perfectly competitive markets
However,workers can work or shirk.
Since performance information is limited,
workers may not get fired.
Asymmetric Information in Labor Markets,Efficiency
Wage Theory
Chapter 17 Slide 66
Without shirking,the market wage
is w*,and full-employment exists at L*
Demand for
Labor
w*
L*
SL
Unemployment in a Shirking Model
Quantity of
Labor
Wage
No-Shirking
Constraint
The no-shirking
constraint gives
the wage necessary
to keep workers
from shirking.
we
Le
At the equilibrium wage,We the
firm hires Le workers
creating unemployment of L* - Le.
Chapter 17 Slide 67
Efficiency Wages at Ford Motor Company
Labor turnover at Ford
1913,380%
1914,1000%
Average pay = $2 - $3
Ford increased pay to $5
Chapter 17 Slide 68
Efficiency Wages at Ford Motor Company
Results
Productivity increased 51%
Absenteeism had been halved
Profitability rose from $30 million in 1914
to $60 million in 1916.
Chapter 17 Slide 69
Summary
Asymmetric information creates a market
failure in which bad products tend to drive
good products out of the market.
Insurance markets frequently involve
asymmetric information because the
insuring party has better information about
the risk involved than the insurance
company.
Chapter 17 Slide 70
Summary
Asymmetric information may make it costly
for the owners of firms to monitor
accurately the behavior of the firm’s
manager.
Asymmetric information can explain why
labor markets have substantial
unemployment when some workers are
actively seeking work.
End of Chapter 17
Markets with
Asymmetric
Information
Chapter 17 Slide 2
本章要讨论的问题质量不确定性与柠檬市场市场信号道德风险委托代理问题
Chapter 17 Slide 3
本章要讨论的问题一体化企业的管理激励问题劳动力市场的信息不对称,效率工资理论
Chapter 17 Slide 4
引言我们将研究不完全信息对资源配置和价格机制所产生的影响。
Chapter 17 Slide 5
质量不确定与柠檬市场在购买一辆二手车时，由于信息不完全，将增加购买的风险并降低消费者的效用；
Chapter 17 Slide 6
二手车市场
假定
买卖双方都能鉴别高质量和低质量的车；
将会出现两个市场；
质量不确定与柠檬市场柠檬问题
PH PL
QH QL
SH
SL
DH
DL
5,000
50,000 50,000
买卖双方能鉴别车的质量时，
将出现高质量和低质量两个市场
10,000
DL
DM
DM
75,00025,000
由于信息不对称，消费者无法确定车的质量，他们将降低对二手车质量的期望 。 Demand for low and high quality
used cars shifts to DM.
DLM
DLM
The increase in QL
reduces expectations and
demand to DLM,The adjustment process
continues until demand = DL.
Chapter 17 Slide 8
The Market for Used Cars
With asymmetric information:
Low quality goods drive high quality goods
out of the market.
The market has failed to produce mutually
beneficial trade.
Too many low and too few high quality cars
are on the market.
Adverse selection occurs; the only cars on
the market will be low quality cars.
Quality Uncertainty
and the Market for Lemons
Chapter 17 Slide 9
Implications of Asymmetric Information
Medical Insurance
Question
Is it possible for insurance companies to
separate high and low risk policy holders?
If not,only high risk people will purchase
insurance.
Adverse selection would make medical
insurance unprofitable.
The Market for Insurance
Chapter 17 Slide 10
Implications of Asymmetric Information
Automobile Insurance
Questions
What impact does asymmetric information
and adverse selection have on insurance
rates and the delivery of automobile accident
insurance?
How can the government reduce the impact
of adverse selection in the insurance
industry?
The Market for Insurance
Chapter 17 Slide 11
Implications of Asymmetric Information
The Market for Credit
Asymmetric information creates the
potential that only high risk borrowers
will seek loans.
Question
How can credit histories help make
this market more efficient and reduce
the cost of credit?
Chapter 17 Slide 12
Implications of Asymmetric Information
The Importance of Reputation and
Standardization
Asymmetric Information and Daily
Market Decisions
Retail sales
Antiques,art,rare coins
Home repairs
Restaurants
Chapter 17 Slide 13
Implications of Asymmetric Information
Question
How can these producers provide high-
quality goods when asymmetric
information will drive out high-quality
goods through adverse selection.
Answer
Reputation
Chapter 17 Slide 14
Implications of Asymmetric Information
Question
Why do you look forward to a Big Mac
when traveling even though you would
never consider buying one at home.
Holiday Inn once advertised,No Surprises” to
address the issue of adverse selection.
Chapter 17 Slide 15
Lemons in Major League Baseball
Asymmetric information and the market for
free agents
If a lemons market exists,free agents
should be less reliable (disabled) than
renewed contracts.
Chapter 17 Slide 16
Player Disability
All Players 4.73 12.55 165.4
Renewed players 4.76 9.68 103.4
Free agents 4.67 17.23 268.9
Days Spent on Disabled List per Season
Precontract Postcontract Percentage Change
Chapter 17 Slide 17
Findings
Days on the disabled list increase for
both free agents and renewed players.
Free agents have a significantly higher
disability rate than renewed players.
This indicates a lemons market.
Lemons in Major League Baseball
Chapter 17 Slide 18
Question
If you are a team owner,what steps
would you take to reduce the
asymmetric information for free agents?
Lemons in Major League Baseball
Chapter 17 Slide 19
Market Signaling
The process of sellers using signals to
convey information to buyers about the
product’s quality helps buyers and sellers
deal with asymmetric information.
Chapter 17 Slide 20
Market Signaling
Strong Signal
To be effective,a signal must be easier
for high quality sellers to give than low
quality sellers.
Example
Highly productive workers signal with
educational attainment level,
Chapter 17 Slide 21
Market Signaling
A Simple Model of Job Market Signaling
Assume
Two groups of workers
Group I,Low productivity--AP & MP = 1
Group II,High productivity--AP & MP = 2
The workers are equally divided between
Group I and Group II--AP for all workers
= 1.5
Chapter 17 Slide 22
Market Signaling
A Simple Model of Job Market Signaling
Assume
Competitive Product Market
P = $10,000
Employees average 10 years of
employment
Group I Revenue = $100,000 (10,000/yr,
x 10)
Group II Revenue = $200,000 (20,000/yr,
X 10)
Chapter 17 Slide 23
Market Signaling
With Complete Information
w = MRP
Group I wage = $10,000/yr.
Group II wage = $20,000/yr.
With Asymmetric Information
w = average productivity
Group I & II wage = $15,000
Chapter 17 Slide 24
Market Signaling
Signaling With Education to Reduce
Asymmetric Information
y = education index (years of higher
education)
C = cost of attaining educational level y
Group I--CI(y) = $40,000y
Group II--CII(y) = $20,000y
Chapter 17 Slide 25
Market Signaling
Signaling With Education to Reduce
Asymmetric Information
Assume education does not increase
productivity
Decision Rule:
y* signals GII and wage = $20,000
Below y* signals GI and wage =
$10,000
Signaling
Years of
College
Value of
College
Educ.
0
$100K
Value of
College
Educ.
Years of
College
1 2 3 4 5 6 0 1 2 3 4 5 6
$200K
$100K
$200K
Group I Group II
CI(y) = $40,000y
Optimal choice of
y for Group I
How much education
should a person obtain?
The education decision
is based on benefits/cost
comparison.
B(y) B(y)
y* y*
B(y) = increase in
wage associated with
each level of education
CII(y) = $20,000y
Optimal choice of
y for Group I
Signaling
Years of
College
Value of
College
Educ.
0
$100K
Value of
College
Educ.
Years of
College
1 2 3 4 5 6 0 1 2 3 4 5 6
$200K
$100K
$200KC
I(y) = $40,000y
Optimal choice of
y for Group I
B(y) B(y)
y* y*
Benefits = $100,000
Cost
CI(y) = 40,000y
$100,000<$40,000y*
y* > 2.5
Choose no education
CII(y) = $20,000y
Optimal choice of
y for Group I
Benefits = $100,000
Cost
CII(yO)= 20,000y
$100,000<$20,000y*
y* < 5
Choose y*
Chapter 17 Slide 28
Signaling
Cost/Benefit Comparison
Decision rule works if y* is between 2.5
and 5
If y* = 4
Group I would choose no school
Group II would choose y*
Rule discriminates correctly
Chapter 17 Slide 29
Signaling
Education does increase productivity and
provides a useful signal about individual
work habits.
Chapter 17 Slide 30
Working into the Night
Question
How can you signal to your employer
you are more productive?
Chapter 17 Slide 31
Market Signaling
Guarantees and Warranties
Signaling to identify high quality and
dependability
Effective decision tool because the cost
of warranties to low-quality producers is
too high
Chapter 17 Slide 32
Moral Hazard
Moral hazard occurs when the insured party
whose actions are unobserved can affect
the probability or magnitude of a payment
associated with an event.
Chapter 17 Slide 33
Moral Hazard
Determining the Premium for Fire Insurance
Warehouse worth $100,000
Probability of a fire:
.005 with a $50 fire prevention
program
.01 without the program
Chapter 17 Slide 34
Moral Hazard
Determining the Premium for Fire Insurance
With the program the premium is:
,005 x $100,000 = $500
Once insured owners purchase the insurance,the
owners no longer have an incentive to run the
program,therefore the probability of loss is,01
$500 premium will lead to a loss because the
expected loss is not $1,000 (.01 x $100,000)
Chapter 17 Slide 35
The Effects of Moral Hazard
Miles per Week0
$0.50
50 100 140
Cost
per
Mile
$1.00
$1.50
$2.00
D = MB
MC’
With moral hazard
insurance companies cannot
measure mileage,MC to $1.00 and
miles driven increases to 140
miles/week--inefficient allocation.
MC
MC is the marginal cost
of driving,With no moral hazard
and assuming insurance
companies can measure miles
driven MC = MB at $1.50 and
100 miles/week--efficient allocation.
Chapter 17 Slide 36
Reducing Moral Hazard
--Warranties of Animal Health
Scenario
Livestock buyers want disease free animals.
Asymmetric information exists
Many states require warranties
Buyers and sellers no longer have an incentive
to reduce disease (moral hazard).
Question
How can this moral hazard be reduced?
Chapter 17 Slide 37
Crisis in the Savings and Loan Industry
Question
How many people know the financial
strength of their bank?
Why not?
Deposit insurance,moral hazard,and
failures in the S&L industry
Chapter 17 Slide 38
Cost of the S&L Bailout
1,000+ failed institutions
$200 billion (1990)
Texas alone--$42 billion (1990)
Agency expenditures--$100 million (1990)
Question
How can this moral hazard be reduced?
Crisis in the Savings and Loan Industry
Chapter 17 Slide 39
The Principal--Agent Problem
Agency Relationship
One person’s welfare depends on what
another person does
Agent
Person who acts
Principal
Person whom the action effects
Chapter 17 Slide 40
The Principal--Agent Problem
Company owners are principals.
Workers and managers are agents.
Owners do not have complete knowledge.
Employees may pursue their own goals and
reduce profits.
Chapter 17 Slide 41
The Principal--Agent Problem
The Principal--Agent Problem in Private
Enterprises
Only 16 of 100 largest corporations have
individual family or financial institution
ownership exceeding 10%.
Most large firms are controlled by
management.
Monitoring management is costly
(asymmetric information).
Chapter 17 Slide 42
The Principal--Agent Problem
The Principal--Agent Problem in Private
Enterprises
Managers may pursue their own
objectives.
Growth
Utility from job
Chapter 17 Slide 43
The Principal--Agent Problem
The Principal--Agent Problem in Private
Enterprises
Limitations to managers’ ability to
deviate from objective of owners
Stockholders can oust managers
Takeover attempts
Market for managers who maximize
profits
Chapter 17 Slide 44
The Principal--Agent Problem
The Principal--Agent Problem in Public
Enterprises
Observations
Managers’ goals may deviate from the
agencies goal (size)
Oversight is difficult (asymmetric
information)
Market forces are lacking
Chapter 17 Slide 45
The Principal--Agent Problem
The Principal--Agent Problem in Public Enterprises
Limitations to Management Power
Managers choose a public service position
Managerial job market
Legislative and agency oversight (GAO &
OMB)
Competition among agencies
Chapter 17 Slide 46
The Managers of
Nonprofit Hospitals as Agents
Are non profit organizations more or less
efficient that for-profit firms?
725 hospitals from 14 hospital chains
Return on investment (ROI) and average
cost (AC) measured
Chapter 17 Slide 47
For-Profit 11.6% 12.7%
Nonprofit 8.8% 7.4%
Return On Investment
1977 1981
The Managers of
Nonprofit Hospitals as Agents
Chapter 17 Slide 48
After adjusting for differences in services:
AC/patient day in nonprofits is 8%
greater than profits
Conclusion
Profit incentive impacts performance
Cost and benefits of subsidizing
nonprofits must be considered.
The Managers of
Nonprofit Hospitals as Agents
Chapter 17 Slide 49
Incentives in the Principal-Agent Framework
Designing a reward system to align the
principal and agent’s goals--an example
Watch manufacturer
Uses labor and machinery
Owners goal is to maximize profit
Machine repairperson can influence
reliability of machines and profits
The Managers of
Nonprofit Hospitals as Agents
Chapter 17 Slide 50
The Principal--Agent Problem
Incentives in the Principal-Agent Framework
Designing a reward system to align the
principal and agent’s goals--an example
Revenue also depends,in part,on the
quality of parts and the reliability of labor.
High monitoring cost makes it difficult to
assess the repair-person’s work
Chapter 17 Slide 51
The Revenue from Making Watches
Low effort (a = 0) $10,000 $20,000
High effort (a = 1) $20,000 $40,000
Poor Luck Good Luck
Chapter 17 Slide 52
The Principal--Agent Problem
Incentives in the Principal-Agent Framework
Designing a reward system to align the principal and
agent’s goals--an example
Repairperson can work with either high or low
effort
Revenues depend on effort relative to the other
events (poor or good luck)
Owners cannot determine a high or low effort
when revenue = $20,000
Chapter 17 Slide 53
The Principal--Agent Problem
Incentives in the Principal-Agent Framework
Designing a reward system to align the principal and
agent’s goals--an example
Repairperson’s goal is to maximize wage net of
cost
Cost = 0 for low effort
Cost = $10,000 for high effort
w(R) = repairperson wage based only on output
Chapter 17 Slide 54
The Principal--Agent Problem
Incentives in the Principal-Agent Framework
Choosing a Wage
w = 0; a = 0; R = $15,000
R = $10,000 or $20,000,w = 0
R = $40,000; w = $24,000
R = $30,000; Profit = $18,000
Net wage = $2,000
Chapter 17 Slide 55
The Principal--Agent Problem
Incentives in the Principal-Agent Framework
Choosing a Wage
w = R - $18,000
Net wage = $2,000
High effort
Chapter 17 Slide 56
The Principal--Agent Problem
Conclusion
Incentive structure that rewards the
outcome of high levels of effort can
induce agents to aim for the goals set by
the principals.
Chapter 17 Slide 57
The Principal--Agent Problem
Asymmetric Information and Incentive Design in
the Integrated Firm
In integrated firms,division managers have
better (asymmetric) information about
production than central management
Chapter 17 Slide 58
The Principal--Agent Problem
Asymmetric Information and Incentive Design in
the Integrated Firm
Two Issues
How can central management illicit
accurate information
How can central management achieve
efficient divisional production
Chapter 17 Slide 59
The Principal--Agent Problem
Possible Incentive Plans
Bonus based on output or profit
Will this plan provide an incentive for
accurate information?
Chapter 17 Slide 60
The Principal--Agent Problem
Possible Incentive Plans
Bonus based on how close the managers
get to their forecasts of output and profits
Qf = estimate of feasible production level
B = bonus in dollars
Q = actual output
B = 10,000 -,5(Qf - Q)
Incentive to underestimate Qf
Chapter 17 Slide 61
The Principal--Agent Problem
Possible Incentive Plans
Bonus still tied to accuracy of forecast
If Q > Qf ;B =,3Qf +,2(Q - Qf)
If Q < Qf ;B =,3Qf -,5(Qf - Q)
Chapter 17 Slide 62
Incentive Design in an Integrated Firm
Output
(units per year)
2,000
4,000
6,000
10,000
0 10,000 20,000 30,000 40,000
Bonus
($ per
year)
8,000
If Qf = 30,000,
bonus is $6,000,
the maximum
amount possible.
Qf = 30,000
Qf = 10,000
If Qf = 10,000,
bonus is $5,000
Qf = 20,000
If Qf = 20,000,
bonus is $4,000
Chapter 17 Slide 63
Asymmetric Information in Labor Markets,Efficiency
Wage Theory
In a competitive labor market,all who wish to
work will find jobs for a wage equal to their
marginal product.
However,most countries’ economies
experience unemployment.
Chapter 17 Slide 64
The efficiency wage theory can explain the
presence of unemployment and wage
discrimination.
In developing countries,productivity
depends on the wage rate for nutritional
reasons.
Asymmetric Information in Labor Markets,Efficiency
Wage Theory
Chapter 17 Slide 65
The shirking model can be better used to
explain unemployment and wage
discrimination in the United States.
Assumes perfectly competitive markets
However,workers can work or shirk.
Since performance information is limited,
workers may not get fired.
Asymmetric Information in Labor Markets,Efficiency
Wage Theory
Chapter 17 Slide 66
Without shirking,the market wage
is w*,and full-employment exists at L*
Demand for
Labor
w*
L*
SL
Unemployment in a Shirking Model
Quantity of
Labor
Wage
No-Shirking
Constraint
The no-shirking
constraint gives
the wage necessary
to keep workers
from shirking.
we
Le
At the equilibrium wage,We the
firm hires Le workers
creating unemployment of L* - Le.
Chapter 17 Slide 67
Efficiency Wages at Ford Motor Company
Labor turnover at Ford
1913,380%
1914,1000%
Average pay = $2 - $3
Ford increased pay to $5
Chapter 17 Slide 68
Efficiency Wages at Ford Motor Company
Results
Productivity increased 51%
Absenteeism had been halved
Profitability rose from $30 million in 1914
to $60 million in 1916.
Chapter 17 Slide 69
Summary
Asymmetric information creates a market
failure in which bad products tend to drive
good products out of the market.
Insurance markets frequently involve
asymmetric information because the
insuring party has better information about
the risk involved than the insurance
company.
Chapter 17 Slide 70
Summary
Asymmetric information may make it costly
for the owners of firms to monitor
accurately the behavior of the firm’s
manager.
Asymmetric information can explain why
labor markets have substantial
unemployment when some workers are
actively seeking work.
End of Chapter 17
Markets with
Asymmetric
Information
