The Spring 2015 Philosophy Colloquium Series presents Andrea Attar, Institute of Advanced Studies, Toulouse School of Economics. The title of Professor Attar's talk is "Incentives and Competition Under Asymmetric Information: Market vs. Non-Market Control." It will be a mainly non-technical discussion of issues about markets and imperfect informaton and the possibility of non-market control. (Abstract below.)
Friday, Apr 3, 2015, 3-5pm, Social Sciences 224 (1145 E South Campus Drive 85721).
Competitive markets are often presented in the academic literature as the prototype of efficient resource allocation, using and aggregating information in an almost perfect way. This view relies on a specific interpretation of the First Theorem of Welfare Economics, which provides a set of sufficient conditions on
economic fundamentals guaranteeing that any allocation sustained in a competitive equilibrium is Pareto efficient. In particular, these conditions require perfect information over agents’ characteristics, and a complete set of risk markets. Recurrent crises cast however some doubts on this vision, and several strands of the literature have raised serious criticisms. The particular idea we focus on is that of private information. For instance, in insurance markets, a policy-holder may be better informed than outsiders about some personal characteristics determining her level of risk, and she can directly affect such risk by taking some actions
unobservable to other agents. The former situation is at the root of adverse selection, and the latter of moral hazard effects.
The lecture aims at showing that the First Theorem of Welfare Economics does not straightforwardly extend to economies with private information. Specifically, we look at markets in which agents trade bilateral contracts, that they design to optimally cope with informational asymmetries. Yet, the behavior of each individual depends on the entire set of relationship she enters into. In decentralized economies, this generates a contractual externality, which implications may be seriously destabilizing. We show two major instances of market breakdown. First, we consider a standard exchange economy in which buyers compete by offering bilateral contracts to trade a divisible good which quality is private information of the seller. In this context, we show that the unique equilibrium allocation features market dysfuncionalities as originally conjectured by Akerlof (1970). The result contrasts standard analyses of private information, which postulate
full observability of agents’ trades. We next consider a capital market under moral hazard. Here, we show that competitive outcomes do not obtain because of the entrepreneurs’ threat to borrow from multiple lenders and shirk. Investors then earn positive rents at equilibrium. We evaluate how enlarging the set of financial instruments available to investors deals with this counterparty externality. Indeed, allowing investors to design potentially sophisticated covenants an even more severe market failure: market equilibria are indeterminate and Pareto-ranked.
Overall, our results suggest that, in markets affected by private information, the strategic behavior of suppliers is a major obstacle to the coordination of economic activities. The normative implications of our analysis can be described as follows. Government intervention can be welfare enhancing even if the market structure is taken as given, and if the informational imperfections cannot be corrected. In these contexts, regulatory interventions would essentially target the supply side of the market without necessary restricting agents’ trade opportunities.