Hidden Information Models

In this chapter, we consider three groups of models: the adverse selectionmodels, the signaling models, and the screening models. In adverse selectionmodel, one of economic actors usually referred as an agent possesses private information about some characteristic affecting payoff of the other agent. For example, a worker may be privately informed about her ability or a used car salesman can be privately informed about the quality of her car. Given a market wage, relatively worseworker is more likely to take a job, since he may have a worse outside option; given a price you are willing topay for a used car, an owner is more likely to sell, if the car is of low quality. Therefore, the name for this kind of phenomena, adverse selection. We will consider three different scenarios. Pure adverse selection models are models where no party cantake any steps to credibly reveal private information. Signaling models are models where the informed party takes a step to reveal her private information, for example, used car salesman issuing a warranty. Screening models refer to situations where the uninformed party tries todevise a menu of contracts that will make the informed party to reveal their information. For example, dividing jobs into easy and complicated ones can force low ability type to opt for the easier job, sinceit will be too hard for them to deal with the complicated tasks and even higher pay will not be enough to compensate for the effort.