– eBay cost is 5% of the Internet auction price. – The maximum price in the local market is $400[r]
(1)Chapter 11
(2)112
Learning Objectives
1 Explain how middlemen add value to market
transactions
2 Use the concept of rational search to find the
optimal amount of information market participants should obtain
3 Define asymmetric information and describe
how it leads to the lemons problem
4 Discuss how advertising, conspicuous
(3)Information and the Invisible Hand
• All parties have all relevant information
– Without free information, market results are not
efficient
• Bargaining for a bowl in Kashmir
• Parties must decide how much information to
gather
(4)114
How The Middleman Adds Value
• Buyers sometimes choose among several
version of a product
– Each has complex feature sets
• Research options
– Company web site
– Ask friends and family
– Consumer Reports, online product reviews
(5)Consumer Choice: Buying DSLR Camera
• Best Denki recommends US$1,200 Nikon
D7100 DSLR camera
– Sales rep seems knowledgeable
• Your next move is
– Thank them and more research
– Trust the sales rep and buy them
– Go home and buy at the best price online ($950)
• Evaluate the importance of
– Immediate possession
– Best price
(6)116
The Value of the Middleman
• Sales representatives supply information to
buyers
– Manufacturers can offer direct sales to bypass
middlemen
• Information makes markets more efficient
(7)Selling Babe Ruth
• Koh wants to sell a Win the War stamp
– His reservation price is $300
– An ad in the local newspaper cost $5
– eBay cost is 5% of the Internet auction price
– The maximum price in the local market is $400
– Two eBay shoppers have secret reservation prices
(8)118
Selling Win the War stamp
• Benefits of eBay
– Card sells for $800 on eBay less $40 commission
• Ellis nets $760, $460 above his reservation price • Buyer surplus is $100
• Local option is inferior
– Card sells for $400 less $5 cost of ad
– Koh nets $395, $95 more than his reservation price
– Buyer surplus is $0
• Economic surplus is increased when a product
(9)$/
un
it
Units of information
MB
The Optimal Amount of Information
• More information is better than less
– Gathering information has a cost
• Marginal benefit starts high, then falls rapidly
– Low-Hanging Fruit Principle
• Marginal cost starts low,
then increases
• Optimal amount of
information is I* where MC = MB
MC
(10)1110
Free Rider Problem
• A free-rider problem exists when non-payers
cannot be excluded from consuming a good
– Interferes with incentives
– Market quantity is below social optimum
• Stores bear the cost of training sales reps on
merchandise
– Shoppers use sales reps as information source
• Then some shoppers buy elsewhere
– Store is unable to capture some of the value it