1、Chapter 9THE ECONOMICS OF INFORMATIONCopyright 2005 by South-Western, a division of Thomson Learning. All rights reserved.1Properties of InformationInformation is not easy to defineit is difficult to measure the quantity of information obtainable from different actionsthere are too many forms of use

2、ful information to permit the standard price-quantity characterization used in supply and demand analysis2Properties of InformationStudying information also becomes difficult due to some technical properties of informationit is durable and retains value after its useit can be nonrival and nonexclusi

3、vein this manner it can be considered a public good3The Value of InformationIn many respects, lack of information does represent a problem involving uncertainty for a decision makerthe individual may not know exactly what the consequences of a particular action will beBetter information can reduce u

4、ncertainty and lead to better decisions and higher utility4The Value of InformationAssume an individual forms subjective opinions about the probabilities of two states of the world“good times” (probability = g) and “bad times” (probability = b)Information is valuable because it helps the individual

5、revise his estimates of these probabilities5The Value of InformationAssume that information can be measured by the number of “messages” (m) purchasedg and b will be functions of m6The Value of InformationThe individuals goal will be to maximizeE(U) = gU(Wg) + bU(Wb) subject toI = pgWg + pbWb + pmmWe

6、 need to set up the LagrangianL = gU(Wg) + bU(Wb) + (I-pgWg-pbWb-pmm)7The Value of InformationFirst-order conditions for a constrained maximum are:8The Value of InformationFirst-order conditions for a constrained maximum are:9The Value of InformationThe first two equations show that the individual w

7、ill maximize utility at a point where the subjective ratio of expected marginal utilities is equal to the price ratio (pg /pb)The last equation shows the utility-maximizing level of information to buy10Asymmetry of InformationThe level of information that a person buys will depend on the price per u

8、nitInformation costs may differ significantly across individualssome may possess specific skills for acquiring informationsome may have experience that is relevantsome may have made different former investments in information services11Information and InsuranceThere are a number of information asymm

9、etries in the market for insuranceBuyers are often in a better position to know the likelihood of uncertain eventsmay also be able to take actions that impact these probabilities12Moral HazardMoral hazard is the effect of insurance coverage on individuals decisions to take activities that may change

10、 the likelihood or size of lossesparking an insured car in an unsafe areachoosing not to install a sprinkler system in an insured home13Moral HazardSuppose a risk-averse individual faces the risk of a loss (l) that will lower wealththe probability of a loss is this probability can be lowered by the

11、amount the person spends on preventive measures (a)14Moral HazardWealth in the two states is given byW1 = W0 - aW2 = W0 - a - lThe individual chooses a to maximizeE(U) = E = (1-)U(W1) + U(W2)15Moral HazardThe first-order condition for a maximum isthe optimal point is where the expected marginal util

12、ity cost from spending one additional dollar on prevention is equal to the reduction in the expected value of the utility loss that may be encountered in bad times16Behavior with Insurance and Perfect MonitoringSuppose that the individual may purchase insurance (premium = p) that pays x if a loss oc

13、cursWealth in each state becomesW1 = W0 - a - pW2 = W0 - a - p - l + xA fair premium would be equal top = x17Behavior with Insurance and Perfect MonitoringThe person can maximize expected utility by choosing x such that W1 = W2The first-order condition is18Behavior with Insurance and Perfect Monitor

14、ingSince W1 = W2, this condition becomesat the utility maximizing choice, the marginal cost of an extra unit of prevention should equal the marginal reduction in the expected loss provided by the extra spendingwith full insurance and actuarially fair premiums, precautionary purchases still occur at

15、the optimal level19Moral HazardSo far, we have assumed that insurance providers know the probability of a loss and can charge the actuarially fair premiumthis is doubtful when individuals can undertake precautionary activitiesthe insurance provider would have to constantly monitor each persons activ

16、ities to determine the correct probability of loss20Moral HazardIn the simplest case, the insurer might set a premium based on the average probability of loss experienced by some group of peopleno variation in premiums allowed for specific precautionary activitieseach individual would have an incent

17、ive to reduce his level of precautionary activities21Adverse SelectionIndividuals may have different probabilities of experiencing a lossIf individuals know the probabilities more accurately than insurers, insurance markets may not function properlyit will be difficult for insurers to set premiums b

18、ased on accurate measures of expected loss22Adverse Selectioncertainty lineW1W2W *W *- lAssume that two individualshave the same initial wealth(W*) and each face apotential loss of lE23Adverse Selectioncertainty lineW1W2W *W * - lSuppose that one person has a probability of loss equal to H, while th

19、e other has a probability of loss equal to lEFGBoth individuals wouldprefer to move to thecertainty line if premiumsare actuarially fair24Adverse Selectioncertainty lineW1W2W *W * - lThe lines show the market opportunities for each person to trade W1 for W2 by buying fair insuranceEFGThe low-risk pe

20、rson willmaximize utility at pointF, while the high-riskperson will choose G25Adverse SelectionIf insurers have imperfect information about which individuals fall into low- and high-risk categories, this solution is unstablepoint F provides more wealth in both stateshigh-risk individuals will want t

21、o buy insurance that is intended for low-risk individualsinsurers will lose money on each policy sold26Adverse Selectioncertainty lineW1W2W *W * - lEFGOne possible solution would be for the insurer to offer premiums based on the average probability of lossHSince EH does notaccurately reflect the tru

22、eprobabilities of each buyer,they may not fully insureand may choose a pointsuch as MM27Point M is not an equilibrium because further tradingopportunities exist for low-risk individualsUHULAdverse Selectioncertainty lineW1W2W *W * - lEFGHMAn insurance policysuch as N would beunattractive to high-ris

23、k individuals, butattractive to low-riskindividuals and profitable for insurersN28Adverse SelectionIf a market has asymmetric information, the equilibria must be separated in some wayhigh-risk individuals must have an incentive to purchase one type of insurance, while low-risk purchase another29Adve

24、rse Selectioncertainty lineW1W2W *W * - lEFGSuppose that insurers offer policy G. High-risk individuals will opt for full insurance.UHInsurers cannot offer any policy that lies above UH becausethey cannot prevent high-risk individuals from taking advantage of it30Adverse Selectioncertainty lineW1W2W

25、 *W * - lEFGUHThe policies G and Jrepresent a separating equilibriumThe best policy that low-risk individuals can obtain is one such as JJ31Adverse SelectionLow-risk individuals could try to signal insurers their true probabilities of lossinsurers must be able to determine if the signals are believa

26、bleinsurers may be able to infer accurate probabilities by observing their clients market behaviorthe separating equilibrium identifies an individuals risk category32Adverse SelectionMarket signals can be drawn from a number of sourcesthe economic behavior must accurately reflect risk categoriesthe

27、costs to individuals of taking the signaling action must be related to the probability of loss33The Principal-Agent RelationshipOne important way in which asymmetric information may affect the allocation of resources is when one person hires another person to make decisionspatients hiring physicians

28、investors hiring financial advisorscar owners hiring mechanicsstockholders hiring managers34The Principal-Agent RelationshipIn each of these cases, a person with less information (the principal) is hiring a more informed person (the agent) to make decisions that will directly affect the principals o

29、wn well-being35The Principal-Agent RelationshipAssume that we can show a graph of the owners (or managers) preferences in terms of profits and various benefits (such as fancy offices or use of the corporate jet)The owners budget constraint will have a slope of -1each $1 of benefits reduces profit by

30、 $136The Principal-Agent RelationshipBenefitsProfitsOwners constraintU1b*If the manager is also the owner of the firm, he will maximize his utility at profits of * and benefits of b*37The Principal-Agent RelationshipBenefitsProfitsOwners constraintU1b*The owner-manager maximizes profit because any o

31、ther owner- manager will also want b* in benefitsb* represents a true cost of doing business38The Principal-Agent RelationshipSuppose that the manager is not the sole owner of the firmsuppose there are two other owners who play no role in operating the firm$1 in benefits only costs the manager $0.33

32、 in profitsthe other $0.67 is effectively paid by the other owners in terms of reduced profits39The Principal-Agent RelationshipThe new budget constraint continues to include the point b*, *the manager could still make the same decision that a sole owner could)For benefits greater than b*, the slope

33、 of the budget constraint is only -1/340The Principal-Agent RelationshipBenefitsProfitsOwners constraintU1b*U2Given the managers budgetconstraint, he will maximize utility at benefits of b* *b*Agents constraint*Profits for the firm will be *41The Principal-Agent RelationshipThe firms owners are harm

34、ed by having to rely on an agency relationship with the firms managerThe smaller the fraction of the firm that is owned by the manager, the greater the distortions that will be induced by this relationship42Using the Corporate JetA firm owns a fleet of corporate jets used mainly for business purpose

35、sthe firm has just fired a CEO for misusing the corporate fleetThe firm wants to structure a management contract that provides better incentives for cost control43Using the Corporate JetSuppose that all would-be applicants have the same utility functionU(s,j) = 0.1s0.5 + j where s is salary and j is

36、 jet use (0 or 1)All applicants have job offers from other firms promising them a utility level of at most 2.044Using the Corporate JetBecause jet use is expensive, = 800 (thousand) if j =0 and = 162 if j =1the directors will be willing to pay the new CEO up to 638 providing that they can guarantee

37、that he will not use the corporate jet for personal usea salary of more than 400 will just be sufficient to get a potential candidate to accept the job without jet usage45Using the Corporate JetIf the directors find it difficult to monitor the CEOs jet usage, this could mean that the firm ends up wi

38、th 0The owners may therefore want to create a contract where the compensation of the new CEO is tied to profit46The Owner-Manager RelationshipSuppose that the gross profits of the firm depend on some specific action that a hired manager might take (a)net profits = = (a) s(a)Both gross and net profit

39、s are maximized when /a = 0the owners problem is to design a salary structure that provides an incentive for the manager to choose a that maximizes 47The Owner-Manager RelationshipThe owners face two issuesthey must know the agents utility function which depends on net income (IM)IM = s(a) = c(a) =

40、c0where c(a) represents the cost to the manager of undertaking athey must design the compensation system so that the agent is willing to take the jobthis requires that IM 048The Owner-Manager RelationshipOne option would be to pay no compensation unless the manager chooses a* and to pay an amount eq

41、ual to c(a*) + c0 if a* is chosenAnother possible scheme is s(a) = (a) f, where f = (a) c(a*) c0with this compensation package, the managers income is maximized by setting s(a)/a = /a = 049The Owner-Manager RelationshipThe manager will choose a* and receive an income that just covers costsIM = s(a*)

42、 c(a*) c0 = (a*) f c(a*) c0 = 0This compensation plan makes the agent the “residual claimant” to the firms profits50Asymmetric InformationModels of the principal-agent relationship have introduced asymmetric information into this problem in two waysit is assumed that a managers action is not directl

43、y observed and cannot be perfectly inferred from the firms profitsreferred to as “hidden action”the agent-managers objective function is not directly observedreferred to as “hidden information”51Hidden ActionThe primary reason that the managers action may be hidden is that profits depend on random f

44、actors that cannot be observed by the firms ownerSuppose that profits depend on both the managers action and on a random variable (u)(a) = (a) + u where represents expected profits52Hidden ActionBecause owners observe only and not , they can only use actual profits in their compensation functiona ri

45、sk averse manager will be concerned that actual profits will turn out badly and may decline the jobThe owner might need to design a compensation scheme that allows for profit-sharing53Hidden InformationWhen the principal does not know the incentive structure of the agent, the incentive scheme must be designed using some initial assumptions about the agents motivationwill be adapted as new information becomes available54Important Po