🙋 Student Q&A (Lecture 11)

Click here to learn about timestamps and my process for answering questions. Section agendas can be found here. Email office hour questions to munger.e1010@gmail.com. PS1Q2=“Question 2 of Problem Set 1”

📅 Questions covered Thursday, Apr 30

Notes

Takeaways:

• Adverse selection means that you are matched with the wrong people (because you have less information than they do. People who are exactly the people you don’t want to do business with delibierately match with you [ie they want to sell you something or want to buy your insurance]). This happens before the market transaction, leading you to be matched with the wrong customers/partners.
• Moral hazard means that the market transaction gives people bad incentives. It makes them do things that are inefficient.

🕣 8:27pm
❔ What is unraveling? It can’t just happen overnight.

✔ It doesn’t. It happens gradually

🕣
❔ Difference between moral hazard and adverse selection?

✔ Covered during review of web pages and slides.

📅 Questions covered Sunday, May 3

🕣 7:45pm
❔ Is there anything to take a second look at? I’m having difficulty with the amount.

✔ Tomorrow’s class meeting will be a review session, and I’ll be taking over. It’ll be in the same Zoom room as the class is usually held in (not a section, because it’ll be the whole class).

We have an entire week to review, which is wonderful, since there’s a lot of material. He’s giving you a full week to focus 100% on it, and I’ll cover the highest-bang-for-the-buck material. We’ll focus on the core concepts and help you remember the key things from throughout the semester.

Unfortunately, there aren’t shortcuts for what’s more important than other things, so everything is fair game. This class is a collection of definitions and concepts, and they can all be covered effectively with simple multiple-choice questions. The exam will look a lot like the midterm, with the same philosophy and bite-sized questions.

The key thing is to make sure you have all the key facts at your fingertips and practice recalling them so you understand them and can use them. You have a full week to do that, which is wonderful, and we’ll kick it off tomorrow.

🕣 7:47pm
❔ When can we get all of our content questions answered?

When will we learn about exam logistics?

✔ Policies same as midterm.

The exam logistics will be the same as the midterm. You will access it on Canvas, and the policies will be the same as before, with new questions.

I’m happy to answer any logistics questions now, but it might be better to wait until tomorrow. I’ll cover the same facts then since more people will be there, and we can cover anything that’s still burning for you.

If you have content questions, feel free to reach out to me by email anytime. We’ll stick to the regular sections according to the regular schedule, unless there’s new material. During exam week, we’ll have the regular sections on Thursday and Sunday, and we’ll also have a review session tomorrow. I’m happy to cover any questions that come up.

🕣 8:23pm
❔ Principal-Agent. Tell me about the relationship between the two. In the example between shareholders and management. Both have their own interests. These are correlated!

✔ We covered a page about the relationship between shareholders and management. They do have overlapping interests, but their interests are not identical. Management wants the firm to do well, and their interests align about 80% of the time, but they differ on about 20%.

Management’s interests can diverge in areas like work-life balance, personal relaxation, private jets, or a beautiful place to work. As a result, they may choose things like a beautiful headquarters or private jets that are more than the shareholders would choose, which reflects a divergence in their incentives.

Shareholders and management are correlated, but when their interests do not align, they make different choices. The principal’s choices ultimately have the impact, and the agent should be acting in the principal’s best interest because the principal has much more at stake.

🕣 8:25pm
❔ What are the effects of adverse selection vs moral hazard?

✔ In general, you can tell when there is adverse selection in a market because lower-quality goods are being sold.

Economists usually assume people are smart and savvy on both sides of a transaction. Just because one party does not have as much information does not mean they are not smart, or that they do not know the lay of the land. They may recognize that many of the available options are lemons, even if they cannot use X-ray vision to immediately diagnose any given item.

In an adverse selection market, lower-quality cars will be sold, so buyers will not be willing to pay as much. They will realize that, in equilibrium, the market has unraveled, and only low-quality cars are being sold. Prices will decline because people know the good stuff is not being sold, and people are keeping it for themselves.

The market can also collapse outright, shrinking as well. That is another thing you will see. Moral hazard will be similar. If there is moral hazard, people will be less likely to do business because the market becomes toxic, and the wrong actions are chosen. Less business will be done, and more of the less efficient or bad actions will be chosen in that market.

To tell whether moral hazard or adverse selection is happening, it may be easier to look at other aspects of the scenario, such as:

• Whether it occurs before or after the transaction
• Whether it is based on hidden characteristics versus hidden actions and differing incentives (as we discussed earlier today)

🕣 8:28pm
❔ General question interpretation from new problem set.

✔ I want to encourage you all to ask lots of interpretation questions and press me hard on them in this assignment. You’re always welcome to ask interpretation questions, and you’ve been around long enough to know I don’t abuse that.

In particular, I think it’s especially important to ask interpretation questions here because the nuances of how you interpret the questions can really matter. You’ve worked enough on this material that you should be able to pick up some of the hints and ask me good questions at this point.