In the famous court case Stambovsky v. Ackley a prospective homebuyer attempts to back out of a purchase after learning that the home was widely believed to be haunted since the current owner had it included in a tour of haunted homes. Prior to the prospective buyer backing out, what imperfect information situation applied to this situation? Explain.

In the famous court case Stambovsky v. Ackley a prospective homebuyer attempts to back out of a purchase after learning that the home was widely believed to be haunted since the current owner had it included in a tour of haunted homes. Prior to the prospective buyer backing out, what imperfect information situation applied to this situation? Explain.

Managerial Economics: A Problem Solving Approach

5th Edition

ISBN:9781337106665

Author:Luke M. Froeb, Brian T. McCann, Michael R. Ward, Mike Shor

Publisher:Luke M. Froeb, Brian T. McCann, Michael R. Ward, Mike Shor

Chapter19: The Problem Of Adverse Selection

Section: Chapter Questions

Problem 19.5IP

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John wants to buy a used car. He knows that there are two types of car in the market, plums and lemons. Lemons are worse quality cars and are more likely to break down than plums. John is willing to pay £10, 000 for a plum and £2, 000 for a lemon. Unfortunately, however, he cannot distinguish between the two types. Sellers can offer a warranty that would cover the full cost of any repair needed by the car for y ∗ years. Considering the type and likelihood of problems their cars can have, owners of plums estimate that y years of guarantee would cost them 1000y, owners of lemons estimate that the cost would be 2000y. John knows these estimates and decides to offer £10, 000 if a car comes with y ∗ years of warranty, £2, 000 if a car comes without warranty. For which values of y ∗ is there a separating equilibrium where only owners of plums are willing to offer the y ∗ -years warranty? Clearly explain your reasoning.
One method of solving this problem is through signaling. Signaling is a strategy one uses when they have information. The goal is to use a signal to convince the buyer that the good or service that is being sold is quality and will meet the buyer's wants. Offer an example of a company that uses a signal to help sell its product. What is the signal? What information is the signal trying to convey? Do you think the signal is effective? Why or why not? Does this signal improve market efficiency? Why or why not?
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You have just received a report suggesting that a chemical your company uses in its manufacturing process is very dangerous. You have not read the report, but you are generally aware of its contents. You believe that the chemical can be replaced fairly easily but that if word gets out, panic may set in among employees and community members. A reporter asks if you have seen the report, and you say no. Is your behavior right or wrong? Explain.
Screening and Imperfect Information Asymmetric information refers to a market where one side (either the buyer or the seller, but usually the buyer) has less information than the other side of the market. When there is asymmetric information in a market, markets are inefficient because the side with less information doesn't want to take the risk involved in buying (or selling) the good or service. One method of solving this problem is through screening. Screening is a strategy one uses when they don't have information. A screen can be any indicator that lets the screener know if the good or service is reliable and will meet the screener's wants. • Offer an example of when you used screening to solve a lack of information. What kind of screen did you use? • Was the screen effective? Were you happy with the result?
What are some ways a seller of labor (that is, someone looking for a job) might reassure a possible employer who is faced with imperfect information?
How might adverse selection make it difficult for an insurance market to operate?
Soft selling occurs when a buyer is skeptical of the usefulness of a product and the seller offers to set a price that depends on realized value. For example, suppose you’re trying to sell a company a new accounting system that will reduce costs by 10%. Instead of naming a price, you offer to give them the product in exchange for 50% of their cost savings. Describe the information asymmetry, the adverse selection problem, and why soft selling is a successful signal.
Problem 1: For each of the following three scenarios state whether these are examples of moral hazard or adverse selection and briefly justify your answer: a) When purchasing a house, there may be dry rot in the walls that the seller knew about but did not report. b) If governments are known to bail out banks that lose money, banks may have less incentive to carefully screen borrowers to make sure they are likely to repay their loans. c) Some doctors may overprescribe treatment and diagnostics compared to what is reasonably justified because their patients are covered by insurance, and so do not pay the full cost of treatment, while the doctor faces legal risk if the patient is undertreated but not if they are over-treated. Assume that the insurance company cannot tell whether a treated is justified in a particular case and must rely on the doctor's judgement.
Participate in a discussion regarding private information as shown in Section 12.3 in the textbook. Signaling occurs when an informed person takes actions that send information to uninformed persons. The grades and degrees that a university awards to students are signals. They inform potential (uninformed) employers about the abilities of the candidates they are considering hiring. What actions (signals) do you plan to take with your existing or potential employers after receiving your college degree?
What are three economic negatives inherent in imperfect information and what would be an alternative approach rationale for each? Thanks.
How information asymmetry can impact economic efficiency. In your answer cover the following: a) What is principal-agent problem? Support your answer with relevant examples. b) What is efficiency wage? Support your answer with appropriate graph.