Now, let us consider the outcome of the game starting from a situation of symmetric information. This is a situation in which the buyer can observe the quality of the product before making his or her purchase decision. In this situation there is no problem of asymmetric information concerning quality. The theory suggests that under these conditions of symmetric information the market outcome is efficient. Here it means that only the medium quality, which generates the largest surplus, is produced and sold. Note that the efficient outcome occurs, although the seller does not have information about the willingness to pay of the buyer. This table summarizes the outcome that was obtained in our classroom game in a situation or of symmetric information. In the first round of the game, both seller 1 and seller 3 decided to produce high quality. and posted the following prices: €18, €5 and €14,49 respectively. These posted prices exceeded the buyers willingness to pay for the high quality. which you may remember is €13,60. So neither seller 1 nor seller 3 were able to sell any unit of the product and made zero profit in this first round. Sellers two, instead, opted for the medium quality and posted a price of €5. Buyers should have been happy to purchase the medium quality at €5. since their WTP for this quality is €8,80. But only one buyer recognized this opportunity and purchased one unit from seller 2. Students playing the role of buyers were evidently still learning. In the second round, seller 1 and seller 3 try to make up for their bad performance with the high quality in round one by producing low quality. they choose a price of €2,40 and €2,99 respectively. Seller 2 produced again the medium quality and this time increased the price to €6,50. Seller 2 was now able to sell both units and so did seller 1. Note that seller 2 made a profit of €3,80. This is equal to the difference between the price received for its unit (€6,50) and the cost of €4,60 and €5,60 incurred in the production of the first and second unit of the medium quality. Seller one instead made a profit of €1 on the first unit and zero profit on the second unit. By round 3, all sellers have figured out that the medium quality provides the largest profit. and all decided to produce the medium quality. In this round the two seller with the lowest price were able to sell their product. Note that the price at which the product was exchanged reached the value of about €5,60. Recall that €5,60 is the crossing point of demand and suuplies for the medium quality. This is the price predicted by theory for the medium quality when the market works. From the 3rd round of the game on producer continued choosing, continue producing the medium quality. Competition among them kept the price at €5,60. We concluded that the market has reached its equilibrium and stopped the game. This outcome of our classroom game confirms that the market worked efficiently. Efficiency comes from the fact the consumer knew the quality of the product before their purchase decisions. At this point, it was time to change the rule of the game to investigate of the market outcome changes with moral hazard and with asymmetric information regarding quality. With the new rules, sellers posted only the price, but not the quality. Hence, buyers were able to discover the quality only after having purchased the product. Everything else stayed the same. This is the outcome of the classroom game with asymmetric information. Recall that now the quality information here in green was displayed only after all buyers have decided whether and from which seller to purchase. In the first round with the new rules, both seller 1 and seller 2 decided to produce the low quality and to sell and to sell it respectively at €5,59 and €5,60. Seller 3 instead decided to produce the medium quality. Evidently, after playing the symmetric information version of the game, seller 3 knew that the medium quality was the most efficient and for this reason, probably, he might have tried, he might have decided to stick to this quality level. In the 1st round no single unit was sold, therefore no surplus was produced in the market. The market collapsed. This is a direct consequence of the asymmetry in the information about quality between buyers and seller. Buyers were unsure regarding the quality reviews by seller and, as in the 2nd hand car example described earlier, they were possibly only willing to pay their value of the lowest quality that is €4. At €5,59 and above, sellers were too expensive given the quality expectations of the buyers. Even seller 3, who was indeed offering a good deal for the buyer, was unable to convince the buyer that his or her quality was above the minimum one. The collapse of the market was an extreme case of market failure. In such situations that we have observed playing this game with other student groups, the market, instead of collapsing completely, reduced its size. It means that fewer units than possible were exchanged. Another outcome that we have observed with our game is the occurrence of rip-offs. This presents a situation in which the seller succeeds in selling low quality at a price that exceeds consumer willingness to pay for the low quality. Let me go back to the classroom game outcome table. In the 2nd round seller 1 & 2 continued to oroduce the low quality, but lowered their price. Seller 3 instead continued producing medium quality, possibly in the hope of building a reputation for delivering good quality and even raised the price from €6 to €6,50. With this strategy seller 3 was able to sell one unit in this round. In summary we can observe that in the present of asymmetric information about quality the exchanged in the market falls to a sub-optimal level. The moral hazard is represented by the behavior of the seller, who reduces the quality trying to rip-off the consumer, who cannot determine the quality of the product at the time of the purchase. The take-home message of the moral hazard problem can be summarized as follows: With asymmetric information regarding quality we see a dramatic decline in the quality exchanged on the market. the price drops too, but often the value that the buyers can enjoy from the sub-optimal quality falls more than the price. Sellers might be able to benefit from selling low quality at a deceptively high price in the short run. But in the long run both buyers and seller stand to lose. Building reputation for quality is a strategy that some firms might try to pursue, but this is difficult and is successful only under certain condition that we will discuss in module 5. With this slide, we conclude the first lesson of module 4 on asymmetric information about quality. Thanks for being with me in this lesson. I will see you in lesson 2 of module 4, entitled product attributes and their classification.
