slides for chaps 14 16 20

MICROECONOMICS: Theory & Applications

Chapter 14 Game Theory and the Economics of Information

By Edgar K. Browning & Mark A. ZupanJohn Wiley & Sons, Inc.9th Edition, copyright 2006PowerPoint prepared by Della L. Sue, Marist College

Copyright 2006John Wiley & Sons, Inc.14-2

Game Theory

Game theory – a method of analyzing situation in which the outcomes of your choices depend on others’ choices, and vice versa

Elements common to all game theory:– Players – decision makers whose behavior we are trying to

predict and/or explain– Strategies – the possible choices of the players– Payoffs – the outcomes or consequences of the strategies

chosen


Repeated Games

Repeated Game Model – a game theory model in which the “game” is played more than once

Tit-for-tat – a strategy in which each player mimics the action taken by the other player in the preceding period

Table 14.6


Asymmetric Information

Imperfect information – the case when market participants lack some information relevant to their decisions

Asymmetric information – a case in which participants on one side of the market know more about a good’s quality than do participants on the other side

The “Lemons” Model


Market Responses to Asymmetric Information

Information is a scarce good. The benefits from acquiring information about

product quality will not always be worth its costs.

It might be efficient for consumers to be less than fully informed.


Adverse Selection

Adverse selection – a situation in which asymmetric information causes higher-risk customers to be more likely to purchase or sellers to be more likely to supply low-quality goods

Application – insurance markets in which the assumption of full information (both firms and customers know the risks) is modified


Market Responses to Adverse Selection

Key: there are potential gains to market participants from adjusting their behavior to account for the adverse selection problem

Examples:– Upper limit on insurance coverage– Requirement of physical exams and/or a waiting

period – Group plans covering all employees


Moral Hazard

Moral hazard – a situation that occurs when, as a result of having insurance, an individual becomes more likely to engage in risky behavior

The problem arises when insurance companies lack knowledge of the actions people take that may affect the occurrence of unfavorable events.


Market Responses to Moral Hazard

Example: medical insurance market– Limitation on the services covered by insurance– Requirement of the insured person to pay part of

the costs: Coinsurance rate – the share of the cost borne by the

patient

– Deductibles – the amount that the patient must pay before insurance coverage is effective


Limited Price Information

Price dispersion – a range of prices for the same product, usually as a result of customers’ lacking price information

Search costs – the costs that customers incur in acquiring information

Price dispersion will fall when the benefit from search is higher than the cost.


Advertising, the Full Price of a Product, and Market Efficiency

Full price – the sum of the money price and the search costs that consumers incur

Advertising is a substitute for the consumer’s own search efforts, and thereby reduce search costs.

Advertising is a low-cost way of conveying information, and thereby increases market efficiency.


Advertising and Its Effects on Products’ Prices and Qualities

Firms advertise to provide information to customers.

Effects of advertising:– Reduce price dispersion and lower the average

price– Solve the lemons problems by giving high-quality

sellers an advantage over low-quality sellers– Introduce consumers to new products


Chapter 16 Employment and Pricing of Inputs



The Firm’s Demand Curve: One Variable Input

Marginal value product (MVP) – the extra revenue a competitive firm receives by selling the additional output generated when employment of an input is increased by one unit

MVP curve = firm’s demand curve for a given input when all other inputs are fixed

Wage rate = MVPL=MPL*P Figure 16.1 (Continued)


The Firm’s Demand Curve: One Variable Input (continued)

Assumption: The firm is a profit maximizer in a competitive market

Conclusions:– The marginal value product curve identifies the

most profitable employment level for the input at each alternative cost.

– The marginal value product curve slopes downward.


The Firm’s Demand Curve: All Inputs Variable

In general, a change in an input’s price leads a firm to also alter its employment of other inputs.

Long-run demand curve Assume that other inputs’

prices are unchanged. Final product’s price is

constant. Figure 16.2


The Supply of Inputs

The general shape of an input supply curve depends critically on the market for which the supply curve is drawn.

Figure 16.5


Chapter 20 Public Goods and Externalities



Public Goods and Externalities

Public goods – those goods that benefit all consumers

Externalities – the harmful or beneficial side effects of market activities that are not fully borne or realized by market participants


What Are Public Goods?

Characteristics:– Nonrival in consumption – a condition in which a good with a

given level of production, if consumed by one person, can also be consumed by others

– Nonexclusion – a condition in which confining a good’s benefits, once produced, to selected persons is impossible or prohibitively costly

Free-Rider Problem– A consumer who has an incentive to underestimate the value

of a good in order to secure its benefits at a lower, or zero, cost– As the group size increases, it is more likely that everyone will

behave like a free rider, and the public good will not be provided.


Externalities

External benefits – positive side effects of ordinary economic activities

External costs – negative side effects of ordinary economic activities

Distinction between externalities and public goods:– External effects are unintended side effects of activities

undertaken for other purposes.– Both are likely to lead to an inefficient allocation of resources.

slides for chaps 14 16 20

Technology

price information search

economics of information

information relevant

game theory game theory

market participants

demand curve

market responses

market efficiency