Soft Selling and Adverse Selection - Assignment Example

Economics Chapter 11: Flight to Safety The reduction of GBP/US dollar exchange rate from 85 in 2008 to 35 in 2009 led to uncertainties in the exchange rates. This reduction in the GBP/US dollar exchange rate meant that the GBP had reduced in its value (Depreciation) relative to the US dollar- the US dollar had appreciated in its value. This meant that buying goods in US dollar was quite expensive than buying goods in GBP. The demand for GBP will therefore increase as consumers would want to purchase using GBP or import foreign goods. That is, the depreciation of the pound relative to the US dollar led to an increase in the demand for ponds. Before purchasing goods using GBP, the consumers must exchange the dollars for pounds hence increased demand for pounds. The increase in demand for pounds will lead to an increased in the quantity of US dollars supplied to the foreign country and a decrease in the supply of pounds. Chapter 12: Pricing Commonly Owned Substitute Products The branded-drug maker offered to pay the generic entrant an amount of $10 million as a way of reducing inter-product cannibalization that would have ensued if the generic drug entered the market/industry. Paying off the generic entrant was a way of ensuring the generic drug stays far away from the branded drugs. With the generic drugs being much cheaper than the branded drugs, the branded drug maker was sure that consumers would go the generic brands and his chances of earning profit would be slim. Paying off the generic drug maker acted as a way of acquiring the substitute good and this means he would increase his profits. Chapter 14: Inter-temporal Price Discrimination In this case, the firm should follow the strategy of inter temporal price discrimination where the price of the product varies with the time the product is bought. Therefore, the firm should sell the iPhone to technophiles at $400 now and sell it to normal people at $250 later. The technophiles are high value consumers in this case while the others are low value consumers. The normal people or low value customers will not purchase the iPhone unless the price is reduced and so the optimal pricing scheme is for the firm to first concentrate on the technophiles. The optimal pricing scheme will also include the production of two versions of iPhone so that the high value customers can get the expensive and high quality one while the low value customers will purchase the low quality depending on the price. Chapter 15: Auditing Game Player row Player Column Prepare Don’t Prepare Audit -20, 20 20, -20 Don’t Audit 20, -20 -20, 20 There is dominant strategy portrayed by either player. Therefore, the equilibrium will be a mixed nash. If any of the players randomizes their selection of action by going 50% one way, then the other player will be made indifferent to their choice of action. Chapter 16: Ultimatum Game I will not the offer of $1 given by the other player. To take the advantage away from the other player in the ultimatum game, I will convince the other player that I will bargain hard regardless of his efforts and this will make him do better by accommodating enabling me to get the lion share of $19. To improve my bargaining position, I will have to increase my opponents gain from reaching the agreement and this would make him more willing to compromise in order to reach an agreement, hence weakening his bargaining position. I will also reduce my own gain from reaching an agreement and this would make me less willing to compromise, hence improving my bargaining position Chapter 17: Boat Insurance If the company wants to make a profit of $200 above its expected cost, then it should set the price of the policy to be $200 more than the expected cost. By doing this, the company will get a high expected revenue hence profit. Chapter 18: Two-Bidder Auction The auctioneer may be lucky to get two high value bidders with the winning bid being $8. However, this outcome occurs only 50% of the time. The remaining 50% will be for the second highest value of $5. Therefore, the expected revenue of the auction will be the weighted average of the two outcomes with the probabilities of each being (0.50($5) + (0.5) ($8) =$6.5. when compared with the fixed price or reserve price of $8, the action then gives the seller higher expected revenue. Chapter 19: Soft Selling and Adverse Selection The information asymmetry in this case is that the seller knows whether he owns a lemon while the buyer is not aware- this case applies the ideas of adverse selection known as lemons problem. The adverse selection problem evident in this case is that the seller does not know which offer is high risk and which one is low risk. There are two different types of consumers in this case with each facing different risks based on the cost reduction percentage provided and this presents an adverse selection problem. Soft selling is a successful signaling as it gets rid of the information asymmetry- it provides consumers with a signal about the quality of products offered. Chapter 20: Business Loan The adverse selection in this case arises from the fact there is hidden information regarding high and low risk loans. To solve this problem my colleague should anticipate adverse selection and know how to protect the bank against it-by lowering the rates. The bank should distinguish between high and low risk loans therefore able to offer good rates for the loans. By doing so the bank will realize that it should lower the rates as it cannot make profit by selling loans at a high rate. The moral hazard explanation for this is that the problem has been caused by information asymmetry. The problem in this case has been caused by hidden actions of the bank. To solve this problem, the bank should get rid of the information asymmetry- the bank should make an observation on whether the customers are getting the appropriate level of information in regard to purchase of loans and therefore solving the problem of moral hazard. References Froeb L.M, and McCann B.T, (2010). Managerial economics: A problem-solving approach. Cengage Learning Read More