Jim is at the farmers’ market. Strawberries are either ‘good’ or ‘bad’, with equal chance of each, based on how quickly they will spoil—sellers know which type of strawberries they are selling, but Jim cannot verify the quality of strawberries before buying. Jim would pay $12 for a container of strawberries that
● Information economics
● asymmetric and imperfect information
● adverse selection
○ hidden type
● signaling and credible signals
● incentive contracts
● moral hazard
○ principal-agent model
○ hidden action
● contract theory
● actuarially fair price
Actuarially fair price: Break even point, ie set price equal to the average cost/damage
he knew were good, but only $5 if he knew they were bad, because he might not be able to enjoy them before they spoil.
What’s the most that Jim would be willing to pay for a container of strawberries? Under what conditions might this situation end up with an ‘adverse selection’ of strawberries being offered for sale? Explain what that means in simple terms.
Say good strawberries spoil quickly 10% of the time, and bad strawberries spoil quickly 50% of the time. Consider a money-back guarantee: if the strawberries spoil quickly, you can return them for a full refund. Can this guarantee be a credible signal of the quality of strawberries? Why or why not