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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

Economics of Information (ECON3016)

Presentation and introduction

slide2
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.
why is economics of information e i an important branch of economics
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…
slide4

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.
why is e i an important branch of economics
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).
why is e i an important branch of economics6
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.
why is e i an important branch of economics7
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
other terms for ei
Other terms for EI?
  • You might also hear EI being referred to as:
    • Contract Theory
    • Agency Theory
what does ei study
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
what does ei study10
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.
is ai important in economics
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
syllabus parts 1 to 8
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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