This document is posted to help you gain knowledge. Please leave a comment to let me know what you think about it! Share it to your friends and learn new things together.
Transcript
Slide 1
ECON0301 Why Trade Liberalization may not be good
Slide 2
Market Failures and Trade Ricardian model and H-O model
predicts that trade liberalization is beneficial assuming the
market functions well. Newer models predicts different outcomes:
Dynamic Learning, External Economies of Scale (recall the Thai
watch industry in the presence of the Swiss watch industry) Infant
industry argument: an infant industry needs protection for it to
thrive In the presence of market failures, whether trade
liberalization is good is uncertain In fact, market failures may be
exacerbated under trade liberalization
Slide 3
External Economies and Market Failure
Slide 4
Other Market Failures A few types of market failures
Involuntary unemployment Credit rationing Bad product drives out
good product These are easily studied by asymmetric
information
Slide 5
Asymmetric Information When a person buys medical insurance,
the insuring company does not know whether the person is healthy.
Nor does it know how well hell take care of himself after insured.
The former type of asymmetry information is called a hidden type
problem, or adverse selection problem. The latter type of
asymmetric information is called a hidden action problem, or moral
hazard problem. But the meaning of moral hazard has subsequently
expanded. Information economics is the study of decision makings
between agents when their information is asymmetric.
Slide 6
Bad Product Drives out Good Product
Slide 7
Adverse Selection Adverse selection refers to a situation where
a selection process (here market) results in a pool of
products/individuals with economically undesirable characteristics.
With hidden type, either (1) bad products drive out good products
or (2) good products subsidize bad products (both receive the same
price). Greshams law: bad money drives out good. Or, where two
media of exchange come into circulation together the more valuable
will tend to disappear.
Slide 8
Adverse selection: Used Cars (Lemons) Market Assumption: all of
the above is commonly known in the following exercises, and all
agents are risk neutral.
Slide 9
Scenario I: Full Information Suppose that every buyer and every
seller know the type of the car they are negotiating. Then both
good cars and bad cars will be traded. There are simply two
products (good and bad cars).
Slide 10
Scenario II: No Information Suppose buyers dont know the type
of the cars they are interested. Also suppose no sellers know the
type of the cars they own. Expected valuation of a car to buyers=
1/3 * $30K + 2/3 * $20K = $23.33K Expected valuation of a car to
sellers = 1/3 * $25K + 2/3 * $10K = $15K Both good cars and bad
cars will be traded!
Slide 11
Scenario III: Asymmetric (Unequal) Information Sellers know the
types of cars they own. But buyers dont know the types of cars they
are going to buy. Is a buyer willing to pay at a price greater than
$25K (say $26K)? No, because there is 2/3 of probability that the
car is bad, and the expected valuation to the buyer=1/3*$30K +
2/3*$20K= $23.33K < the price
Slide 12
Scenario III: Asymmetric (Unequal) Information Is a buyer
willing to pay a price of $22K to buy a car? No, at such a low
price, only bad cars owners will sell their cars. But bad cars are
worth only $20K to the buyer. $22K is too high a price. The market
price is even lower, at $20K or somewhat lower. Only bad cars will
be traded. Good cars dont find a buyer!!! Remark: What matters is
not the amount of information.
Slide 13
Scenario III: Asymmetric Information Good cars may still find a
buyer, if the probability of bad cars in the pool is low. Let p be
such prob. A buyer is willing to pay $25K if (1- p)x$30K +
px$20K>$25K, or p