Question

In each of the following cases, explain how the advertisement functions as a signal to a potential buyer. Explain what information the buyer lacks that is being supplied by the advertisement and how the information supplied by the advertisement is likely to affect the buyer's willingness to buy the good. a. "Looking for work. Excellent references from previous employers available." b. "Electronic equipment for sale. All merchandise carries a one-year, no- questions-asked warranty." c. "Car for sale by original owner. All repair and maintenance records available."

Short answer

A: References reduce uncertainty about the worker's quality. B: Warranty signals product quality and reduces buyer's risk. C: Maintenance records provide transparency about the car's history, increasing buyer confidence.

Step-by-step solution

Case A Analysis - Employment Advertisement

This advertisement signals to the potential employer that the person seeking employment has a history of satisfactory work performance, which is supported by references from previous employers. The lack of information the employer has is about the candidate's reliability and competence. The references serve as evidence of the candidate's quality as an employee, increasing the employer's willingness to consider hiring them.

Case B Analysis - Electronic Equipment Sale

The advertisement assures the buyer of the product's reliability through the offer of a one-year warranty. The potential buyer lacks information about the quality and durability of the electronic equipment. The warranty reduces the perceived risk of purchasing defective merchandise and suggests a commitment to customer satisfaction from the seller, thus increasing the likelihood of a purchase.

Case C Analysis - Car Sale by the Original Owner

This advertisement presents verifiable information with the availability of all repair and maintenance records. The buyer lacks information about the car's condition and history. Access to comprehensive records can allay concerns about the vehicle's past and hidden issues, increasing the buyer's confidence and willingness to buy the car.

Key concepts

Asymmetric Information

Asymmetric information refers to situations where one party in a transaction has more or better information than the other. This imbalance can often lead to problems in markets, like adverse selection or moral hazard.

In the context of economics, imagine you're buying a used car but don't know whether it's in good condition. The seller, who's been driving it, knows it perfectly well. Because of this asymmetry, you might hesitate to buy, or the seller might fail to get a fair price. It's a classic example of the issues that arise when one side of a transaction holds more cards than the other.

Market Signaling

Market signaling is a way to reduce the problems caused by asymmetric information. It refers to the actions taken by informed parties to reveal information to the uninformed. Signals often come at a cost, but they help align perceptions with reality.

For instance, when a worker includes 'Excellent references from previous employers' in their job ad, they're signaling their quality as an employee. It's costly to fake good references consistently, so this serves as a credible signal to potential employers about the worker's competence.

Consumer Behavior

Consumer behavior is the study of how individuals make decisions to spend their resources on consumption-related items, including what they buy, why, where, and how often.

For example, a buyer might be more inclined to purchase electronic equipment that carries a 'one-year, no-questions-asked warranty.' Such a warranty can significantly influence consumer behavior by reducing the perceived risk involved in the purchase.

Product Warranties

Product warranties are assurances given by sellers that their products will perform to a certain standard or will be free from defects for a particular period. They are a powerful form of market signaling.

A 'one-year, no-questions-asked warranty' on electronics communicates reliability and confidence in product quality. Not only does this reduce the asymmetry of information, but it also shifts some of the risk from the buyer to the seller, making it a strong influence on the purchase decision.

Employment References

Employment references are endorsements from previous employers about an individual's performance and can play a critical role in the hiring process.

By stating 'Excellent references from previous employers available,' a job searcher is signaling their credibility and reliability. It helps potential employers overcome the asymmetric information problem by providing them with verified information about the candidate's past work experiences and skills.