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Economics of Information (ECON3016)

Economics of Information (ECON3016). Presentation and introduction. Lecturer: Dr. Marcos Vera-Hernández Office: Drayton House, 203 Office hours: Note: My office hours are for the purpose of addressing questions relating to the course. I will not deal with those over email.

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Economics of Information (ECON3016)

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  1. Economics of Information (ECON3016) Presentation and introduction

  2. Lecturer: Dr. Marcos Vera-Hernández • Office: Drayton House, 203 • Office hours: • Note: My office hours are for the purpose of addressing questions relating to the course. I will not deal with those over email.

  3. Why is Economics of Information (E.I.) an important branch of economics? • Standard economic theory assumes that firms and consumers are fully informed about the commodities that they trade. • However this is not always realistic for some markets. Some examples…

  4. Why is (E.I.) an important branch of Economics? • Medical services: A doctor knows more about medical services than does the patient. • Insurance: An insurance buyer knows more about his riskiness than does the insurance company. • Used cars: The owner of a used car knows more about it than does a potential buyer.

  5. Why is (E.I.) an important branch of Economics? • Markets in which one or both sides are imperfectly informed are markets with imperfect information. • Imperfectly informed markets in which with one side is better informed than the other are markets with Asymmetric Information (AI).

  6. Why is (E.I.) an important branch of Economics? • The First Theorem of Welfare Economics (studied in Microeconomics ECON2001) proved that under some assumptions, the market leads to an efficient solution • Symmetry of information is one of those assumptions • The market does not necessarily lead to an efficient solution when information is asymmetric • AI. is a market failure. It might justify policy intervention, e.g. compulsory car insurance.

  7. Why is (E.I.) an important branch of Economics? • When AI is present, if participants have opposing objectives, it is natural to think that: • The more informed party will act in a way so as to benefit from her informational advantage • The less informed party will also act in a way so as to overcome her informational disadvantage • These actions will have implications for the contracts that they agree to sign • This will have consequences on the efficiency and existence of the market • The existence of markets and their efficiency are important topics in economics

  8. Other terms for EI? • You might also hear EI being referred to as: • Contract Theory • Agency Theory

  9. What does EI study? • EI studies the types of contracts that will emerge in equilibrium in relationships (markets, contracts) in which: • one party has more information than another over at least one variable that influences how much they value their mutual relationship (profits, utility) • Consumer knows more about their health risk than the medical insurance company • The participants in the relationship have opposing objectives • If ill, the insured consumer would like to go to the best hospitals, receive the best treatments etc.; insurance company on the other hand would like to minimize payments • EI also studies the implications that the information asymmetry has on the efficiency of the relationship and the existence of the market

  10. What does EI study? • Many managers are paid according to their firm’s profits. This is their remuneration contract. We will see that AI can explain why contracts with variable payments are used. • When renting a car, one can choose to pay the standard insurance premium and be liable for the first £600 in case of damage to the car or to pay a higher premium and be liable for 0 (fully insured). We will see that AI can explain why insurance companies offer not just one but several contracts.

  11. Is AI important in Economics? • Information Asymmetry is likely to be an important feature in many markets and fields: labour, health, insurance, agriculture, quality of goods, regulation… • Possibly the area of economic theory that has evolved most over the past 20 years • 2001 Nobel prize in Economics was awarded to Professors Akerlof, Spence, and Stiglitz for their analyses of markets with asymmetric information • See: this link

  12. Syllabus: Parts 1 to 8 • Part 1. Presentation and overview (this one) • Part 2. Review of decision theory under uncertainty (Read your microeconomics book from last year) • Part 3-7. Theory of EI. Most relevant book: Macho-Stadler, I. and Pérez-Castrillo, J.D. “An Introduction to the Economics of Information. Incentives and Contracts”. Oxford University Press. 2001. Second edition. • The book includes solutions to many exercises • Part 8.The empirical relevance of incentives and asymmetric information: development, insurance, and health economics. The reading list for this part might change.

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