ESSAYS ON THE ECONOMICS OF ASYMMETRIC INFORMATION

This dissertation investigates the effects of asymmetric information on economic allocations. Relative to the classical economic model of perfect information, allocations obtained in environments in which agents are privately informed about realizations of random variables will generally be inefficient. In these situations, prices play an important role in conveying information across traders and the market structure itself is directly influenced by the information asymmetries.

Chapter 1 considers the role of asymmetric information in providing a basis for wage rigidities in a simple general equilibrium model. Our results indicate that the trade of non-contingent claims can support an optimal allocation of real risks. Hence the incompleteness of markets due to asymmetric information leads to the use of predetermined trades to allocate risks. Future research will extend this model to include a nominal shock as well.

The distortions due to asymmetric information are discussed in Chapters 2 and 3 of the thesis. Chapter 2 considers a general model of self-selection and characterizes the inefficiencies created by the need to extract private information. The discussion includes a sufficient condition for the use of randomization as a sorting mechanism. Chapter 3 investigates the effects of bilateral asymmetric information in the context of labor contracts. In general contracts must allocate labor time, share risks and provide incentives for the revelation of private information. The optimal contract under bilateral asymmetric information includes both overemployment and underemployment as a means of eliciting this private information.

Finally, the role of prices in transmitting information about product quality from informed to uniformed traders is discussed in Chapter 4. In a competitive market, dishonest firms will provide low quality goods at high prices to take advantage of uninformed agents who use prices as signals of quality. The information on quality conveyed by prices depends on the shape of the average cost curves and the relative numbers of informed and uninformed traders. If the product market is monopolized, the solution with some uninformed traders will be identical to the perfect information solution when agents have identical tastes. Once agents tastes differ, the monopolist can randomize quality as a means of extracting additional consumers' surplus.