Exploring Screening and Signaling

1. In the past banks and savings and loan associations were accused of "redlining," that is, refusing to make any mortgage loans in certain segments of a city. Why might they redline?

2. In some transactions, there is a real risk that one party may cheat the other. People do not trust traveling salesmen, and there is good reason for that distrust. (Can you explain why traveling salesmen have a greater incentive to cheat customers than the local merchant?)

As the Internet grew, it became possible for people all over the world to buy and sell from one another. However, commerce was limited by the cheating problem. How could you as a buyer trust someone who offered something for sale on the Internet? The author remembers buying and selling on usenet in the early 1990s, and dishonest sellers (and to a lesser extent, dishonest buyers) were a common and serious problem.

A solution to the cheating problem was discovered by the people who established the eBay auction site. Their solution made buying from and selling to individuals much less risky, and they were rewarded with a very successful company. Visit www.ebay.com and see if you can discover the way they discovered that allows buyers and sellers, who are complete strangers, to have some confidence that they are dealing with people who will not cheat them. (Comment: the method they discovered is now routine on auction sites in which anyone can buy or sell.)

3. Professor Langis has an unruly class of students who are debating whether or not there should be a final exam. After putting up with their whining for a while, he tells the class that he will let them vote on whether they will have a final. Six vote for a final, eight vote against, and four abstain. Professor Langis then announces that there is no need for a final. To compute their final grades, he will add a bit to the scores of those who voted for the final, subtract a bit from those who voted against the final, and leave unchanged the scores of those who abstained. Those who voted against the final are outraged and accuse Professor Langis of being vindictive. However, the good professor tells them that he is just using the economics of signaling and that what he is doing is completely logical. Explain Professor Langis' reasoning.

4. Quite a few years ago there was a television series, Columbo, about a police detective who solved murder cases in which the guilty individual was rich, successful, and sometimes famous. Columbo dressed poorly, drove an older car, and spoke in a way that suggested that he was not too bright. He usually solved the case when the guilty party underestimated him and made a mistake. How did this series illustrate the idea of ability signaling?

5. In the software industry there used to be, and maybe still is, a distinction between the shirts and suits. The shirts where people who came to work in basically anything--often a tee shirt. (At one time, there was a male programmer at Apple Computer who regularly came to work in a dress.) The suits were people who had to dress nicely at work. What was the key to determining whether a person was a shirt or a suit?

6. Even most small colleges spend tens of thousands (or maybe even hundreds of thousands) of dollars on lawn care and landscaping. There is no compelling evidence that a prettier campus makes students study more or better. Why then do colleges make these expenditures?

7. In the process of hiring, employers are legally forbidden to ask for certain sorts of personal information. For example, the law prohibits employers from asking applications about marital status. Economists who have studied signaling suspect that these laws have virtually no effect. Why?

8. Many decades ago some economists were upset with the market concentration that brand names gave companies. They suggested that it might be a good idea to let other companies use the brand names of the dominant companies as a way to get more competition in the market. For example, the dried cereal market was and still is dominated by three or four firms. If other companies were able to market Kellogg Frosted Flakes, there would be more competition and presumably lower prices. Once economists developed the ideas of asymmetric information and signaling, these sorts of proposals disappeared. Why?


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