1. The purpose of antitrust policy is to promote __competition among firms_____, which leads to lower __price for customers______. Explain why this is so? The purpose of antitrust policy is to promote competition, which leads to lower prices. If a company had the power of price control that comes with being a monopoly, they would profit by picking the quantity/price that equals the highest revenue for their company. This would be likely a lower quantity and higher price than would prevail if there was competition. Combining operations could lead to greater efficiency. Cost savings could come by combining HR or accounting depts. The main problem with cost savings is that a monopoly does not have the pressure to operate efficiently.
2. Assume a healthy baseball pitcher is worth $5 million per year to his team, compared to only $1 million for an unhealthy one. According to a baseball executive, “If my assumptions are correct, our team is willing to pay a maximum of $3 million for a pitcher in the free-agent market.” What are the executive’s assumptions? Are these assumptions realistic? The executive is assuming that there is asymmetric information out there about certain pitchers, meaning that the team that is “selling” the players has more information on his health than the uninformed buyer, the executive. So a reasonable assumption is that the executive will split the difference in the mixed market and pay the average, which is $3 million. The executive does have realistic assumptions, simply for the fact that he has asymmetric information, and is not fully notified of the players’ injury status.
3. Imperfect information can go both ways. What are some examples (your own, not from the text) of market situations in which the seller has more information than the buyer and some examples in which the buyer has more information than the seller?
One example where the seller knows more than the buyer would be when you are purchasing a house, the buyer does not know if there are any problems with the foundation or roofing or if all the appliances work well or will continue to work well. The seller does know, because they have lived there long enough to know what is in good shape and what is in bad shape on the house. An example of the buyer knowing more than the seller is in the antique market, because the buyer may know more history about what they are buying than the seller. The seller may not have put as much time into researching the products.
4. Critical Thinking: All states, of which I am aware, require automobile owners to insure their vehicle. Yet, studies show that having insurance actually increases the likelihood of an accident and increases the likelihood of a car / bicycle accident. Discuss why this is so. Who is protected and who is harmed by required automobile insurance? The reason that having insurance increases the likelihood of an accident is due to the moral hazard associated with car insurance. This is a situation in which one side of an economic relationship takes undesirable or costly actions that the other side cannot observe. For instance, Mary’s car insurance company doesn’t know that she occasionally texts while driving because they can’t physically see her driving.
Mary does this because she assumes that if anything happens, she is insured and she will be able to financially cover the costs of any accident. It takes the responsibility off of Mary (slightly) and puts it on the insurance company which makes Mary act more recklessly. The person driving the vehicle is somewhat more protected because of insurance. They are able to financially cover losses to other drivers due to their negligence and risk taking. However, the other drivers on the road and the pedestrians that may be out walking are harmed by this added moral hazard because, let’s face it, all the insurance in the world won’t bring someone back if Mary is texting and driving and kills them.