Chapter 22 - Frontiers of Microeconomics

Asymmetric information: some people are more informed than others, affecting how they make choices and how they interact with each other
Political economy: how markets fail and how government policy can potentially improve situations
Behavioral economics: how human behavior can be more subtle, complex, and realistic than the one in conventional economic theory

22-1 Asymmetric Information

Moral hazard: the tendency of a person who is imperfectly monitored to engage in dishonest or otherwise undesirable behavior
Agent: a person who performs an act for another person, called the principal
Principal: a person for whom another person, called the agent, performs some act
- Ex: employers are principals, workers are agents
There are ways to reduce moral hazards
- Better monitoring, using cameras, to record behavior.
- Higher wages incentivize workers to work higher.
- Delayed payment, so if workers are caught and fired, they suffer a larger penalty.

Adverse selection: the tendency for the mix of unobserved attributes to become undesirable from the standpoint of an uninformed party
Customers are more suspicious and are likely to avoid getting a product if the seller might know something they won’t tell the buyers

Signaling: an action taken by an informed party to reveal private information to an uninformed party
Signals must be less costly to the person with the higher-quality product.
- EX: The “as seen on TV” advertisement commonly seen on many products signals a company is willing to spend money on advertising.

Screening: an action taken by an uninformed party to induce an informed party to reveal information
This usually includes questioning about a product or service.

When information is not distributed equally, the market may not be as efficient.
This justifies government action in some cases. HOWEVER:
- The market can fix itself and the asymmetric information via signaling and screening.
- The government may not have enough information to deal with the private properties.
- The government is not a perfect institution.

Political economy: (also known as a public choice) the study of government using the analytic methods of economics

Most advanced societies rely on democracy to build government policy.
This usually includes the majority wins, but sometimes it runs into problems
Condorcet paradox: the failure of majority rule to produce transitive preferences for society
The order of the items to vote on affects the outcome.
A majority voting by itself may not tell what society really wants.

Unanimity: If everyone prefers A to B, then A should beat B.
Transitivity: If A beats B, and B beats C, then A should beat C.
Independence of irrelevant alternatives: The ranking between any two outcomes A and B does not depend on third outcome C.
No dictators: There is no person who always gets their way.
Arrow’s impossibility theorem: a mathematical result showing that, under certain assumed conditions, there is no scheme for aggregating individual preferences into a valid set of social preferences
No matter the voting system, there will always be a flaw.

Median voter theorem: a mathematical result showing that if voters are choosing a point along a line each voter wants the point closest to his most preferred point, then majority rule will pick the most preferred point of the median voter
A median voter is a voter in the middle of the distribution of votes.
Politicians will move positions to the one favored by the median voter to maximize their chance of election.

Behavioral economics: the subfield of economics that integrates the insights of psychology

Homo economicus refers to human organisms that are always rational, which is studied in economic theory.
However, people in real life aren’t always national.
Humans aren’t maximizers, but satisficers.
They make decisions that are good enough, but not perfect.
Other findings:
- People are overconfident
- People give too much weight to a small number of vivid observations.
- People are reluctant to change their minds.