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The Economists

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Sheryl Ratnam

on 23 October 2014

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Transcript of The Economists

Theory of Asymmetric Information
The Economists
By Meena Rajan, Sheryl Ratnam Yanika Magan
Prior Economic Thoughts and Norms
George A. Akerlof
Michael Spence
Joseph STIglitz
Smith and Marx
George Akerlof, Joseph Stiglitz,
& MIchael Spence
Started thinking about economics at the age of 10
Ph.D. from Yale University; Professor of Economics at UC Berkeley
Married to Janet Yellen (Chairwoman of Board of Governors of the Federal Reserve)
Has researched involuntary unemployment, social issues of identity, class formation, etc.
Theory: The Market For Lemons
Asymmetric information between two parties produces adverse selection
-Market for used cars
-Low-end ('lemon') & high-end ('gem') products
-2 separate market prices presented by seller
Actions of BUYER and SELLER
-Buyer offers a price that is the average of the two market prices
-Seller chooses to sell the lemon instead of the gem
The Effect
-Seller can only sell the lemon because the price offered by buyer is made without information of quality, and offers no benefit for gem-sale
-Adverse selection occurs as high-quality 'gems' are pushed out of the market
Interest in economics inspired by teachers
Influenced by Kenneth Arrow who taught him about economic equilibrium
Worked with Tom Schelling and Richard Zeckhauser who educated him on topics i.e. adverse selection, moral hazards, etc.
Other works include managing resource revenues, monopolistic competition, welfare, and the employment challenge
Application of Concepts: Signaling
Theory: Signaling
-Signaling is one solution for adverse selection
-Observable actions taken by one party to ensure another party of the quality of a product
-Purchasing behavior adjusts accordingly
Employer-Employee Situation
-Important signal is level of education

-Education level conveys the level of productivity in a company

-Employer relies on signals to know the full potential of employee

-Relative- signaling doesn't succeed without signaling cost differing between senders

Attended Amherst College and received Ph.D from MIT
Chairman of Council of Economic Adviors under Clinton
SVP and Chief Economist at the World Bank
Observed early on that information was imperfect
Influenced by other Nobel Prize winners for theories on economic equilibrium
Application of Concepts: Screening
Theory: Screening
-An uninformed agent extracts information from an informed party; balances the asymmetry
-Altered the traditional models of markets by proving inefficiency and imperfection
The Situation
-(Uninformed) Companies lack information regarding the (informed) individuals
The Solution
-Company offers a series of choices involving risks and incentives
-Customer's choice reveals information about them
Adam Smith
-Believed in laissez-Faire
-Adverse selection and asymmetric information deters capitalism but govt. can't solve
-Agreed with the merits of signaling and screening

Karl Marx
-Believed in a communist economy
-In this economy, asymmetric information wouldn't exist due to laborers and production of goods
-No room for free-market operations due to govt. control
Adam Smith
: high interest rates push out best borrowers

Alfred Marshall:
employers do not have enough information to pay workers on quality

Berle & Means
: principal-agent problem

Kenneth Arrow
: asymmetric information in health care

Mirrlees and Vickey
: theory of incentives
The Impact on Future Economists' Work
- Furthered understanding of phenomena in real markets
- Helped to explain market failure in depth including causes for economic collapse
-Later theories developed by Mankiw and Mishkin

Akerlof, George A. "The Market for "Lemons": Quality Uncertainty and the Market Mechanism." The Quarterly Journal of Economics 84.3 (1970): 488-500. Jstor. Web. 18 Oct. 2014.

"A. Michael Spence - Biographical". Nobelprize.org. Nobel Media AB 2014. Web. 22 Oct 2014.

"George A. Akerlof - Biographical". Nobelprize.org. Nobel Media AB 2014. Web. 22 Oct 2014.

"Joseph E. Stiglitz - Biographical". Nobelprize.org. Nobel Media AB 2014. Web. 21 Oct 2014.

"Joseph E. Stiglitz". Encyclopædia Britannica. Encyclopædia Britannica Online.
Encyclopædia Britannica Inc., 2014. Web. 17 Oct. 2014

Levin, Jonathan. "Information and the Market for Lemons." RAND Journal of Economics (2001): 657-66. Jstor.com. Web. 18 Oct. 2014.

Spence, Michael A. "Market Signaling: Informational Transfer in Hiring and Related Screening Processes." Cambridge, MA: Harvard University Press (1974). Web. 19 Oct. 2014.

Stiglitz, Joseph E. ""The Theory Of" Screening," Education, and the Distribution of Income."" The American Economic Review (1975): 283-300. Web. 19 Oct. 2014.
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