Chapter Outline

Information is not free, and so economic principles apply to its production and allocation.
Information must be costly to fake.
1. Strategic entry deterrence comes from high fixed costs, which are hard to fake.
2. Product quality assurance appears more credible when a firm has high fixed costs that indicate the considerable investment at risk if product quality is low.
3. A trustworthy employee can signal his loyalty by highlighting significant voluntary contributions to society.
Good information results in the full disclosure of other relevant information.
1. If a product guarantee does not fully reflect what its quality will merit, people will think it is worth less than it is.
2. If someone does not volunteer good information about herself in an interview, the interviewer may assume the worst on the issue in question.
A corollary of the full-disclosure principle is the lemon principle.
1. Used merchandise will have a higher defect rate than the overall merchandise population, because the “lemons” in the population will find their way into the market at a greater rate than the high quality goods.
2. Newcomers are often suspect of being mobile for an undesirable reason. This stigma can be analyzed using the same tools developed in studying the market for used goods.
3. Individuals who need matching-service help in finding friends are assumed to have a character flaw that makes friendship with them difficult.
4. Adverse selection occurs when undesirable members of a population are more likely to participate in a voluntary exchange, such as insurance policies.
Conspicuous consumption often signals success and high skill, although it tends to be a positional good.
Statistical discrimination occurs when decisions are made using group averages rather than individual observations because of the difficulty of getting detailed information on individuals.
Because the future is uncertain,
1. a risk-averse person’s preferences can be described with a concave utility function as he prefers a certain level of wealth to an expected wealth level of the same amount. He will refuse a fair gamble, and will be willing to pay insurance to avoid risk taking.
2. a risk-seeking person will have a convex utility function, will accept a fair gamble, and will even be willing to pay to absorb risk.
3. a risk-neutral person has a linear utility function, will be indifferent to a fair gamble, and will not pay to absorb or avoid risk.
4. insurance premiums can be charged up to the point where the insured person's utility from wealth minus the insurance premium is equal to the expected utility of the individual if uninsured.
It is advisable to self-insure against small losses
It is advisable to insure against large losses.
(Appendix) The search for high wages and low prices is a process of assessing the marginal benefit of the search and the marginal cost of the search.
1. The benefit of job search is the gain from sampling an additional job vacancy.
2. Costs of additional search include the opportunity and resource costs of the individual conducting the search.
(Appendix) The winner in an auction will be the individual who holds the highest valuation of the good being bid on.
1. If value estimates are distributed uniformly around the true value, the winner almost always pays more than the true value.
2. The winner's curse can be avoided if all bidders adjust their bid downward.

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