Friday
Mostly summarized from Gregory Mankiw’s Principles of Economics, 5th Ed.
PART 7 Topics for Further Study
Chapter 22 of 36 Frontiers of Microeconomics
Section 1 of 18
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Asymmetric Information
Hidden Actions: Principals, Agents, and Moral Hazard
Hidden Characteristics: Adverse Selection and the Lemons Problem
Corporate Management
Signaling To Convey Private Information
Gifts As Signals
Screening To Induce Information Revelation
Asymmetric Information and Public Policy
Political Economy
The Condorcet Voting Paradox
Arrow's Impossibility Theorem
The Median Voter Is King
Politicians Are People Too
Behavioral Economics
People Aren't Always Rational
People Care About Fairness
People Are Inconsistent Over Time
… …
Summary of Chapter 22: Frontiers of Microeconomics, Gregory Mankiw, Principles of Economics, 5th Ed.
Grok:
This chapter explores advanced, evolving topics in microeconomics that extend beyond perfect markets and rational behavior.
It focuses on three key "frontiers":
1. asymmetric information
2. political economy
3. behavioral economics
These areas highlight real-world imperfections in markets, government decision-making, and human rationality.
1. Asymmetric Information
Traditional models assume full market information, but in reality, one party often knows more than the other, leading to market inefficiencies.
Hidden Actions and Moral Hazard:
One party engages in undesirable behavior because actions are imperfectly monitored.
Examples include workers shirking duties or insured individuals taking fewer precautions.
This creates a principal-agent problem, e.g., employers vs. employees and shareholders vs. managers.
Solutions include better monitoring, incentives like efficiency wages -paying above market to deter shirking-, or delayed compensation e.g., bonuses.
Hidden Characteristics and Adverse Selection:
Sellers know more about product quality than buyers, leading to low-quality goods dominating the market, e.g., "lemons" in used cars, or high-risk individuals buying more insurance, driving up premiums.
Markets respond with
- signaling, informed party reveals quality, e.g., with warranties, education credentials
- screening, uninformed party induces revelation, e.g., insurance deductibles Private solutions often mitigate issues effectively, and government intervention may or may not improve outcomes.
2. Political Economy
This applies economic tools to government and voting systems.
Condorcet Paradox:
Majority rule can produce inconsistent societal preferences.
For example, with three options and voter groups, pairwise voting might show A > B, B > C, but C > A creating cycles with no clear winner.
This shows voting outcomes can depend on agenda order and fail to reflect true societal preferences.
Arrow's Impossibility Theorem:
No voting system can perfectly aggregate individual preferences while satisfying fairness criteria including unanimity, transitivity, independence of irrelevant alternatives, and no dictatorship.
Median Voter Theorem:
In majority rule along a spectrum, e.g., policy levels, the outcome favors the median voter's preference.
Politicians thus converge toward centrist positions to appeal to the middle voter, often sidelining extremes.
Politicians may also act in self-interest e.g., wanting to be re-elected rather than wanting to do the economically best thing, diverging from public good.
3. Behavioral Economics
This integrates psychology, challenging the assumption of perfect rationality.
People deviate systematically:
They may overvalue immediate rewards leading to undersaving, prioritize fairness e.g., rejecting unfair offers in games despite personal loss, or exhibit biases like overconfidence or reluctance to update beliefs.
Examples include the ultimatum game -proposers offer fair splits to avoid rejection- and commitment devices to overcome self-control issues.
The chapter concludes that while these frontiers reveal limitations in traditional models, markets, governments, and individuals usually find ways to cope.
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