Behavioral Macroeconomics and Macroeconomic Behavior Part I : Asymetric Information
[I. Asymmetric Information]

I first came upon the problems resulting from
asymmetric information in an early investigation
of a leading cause for fluctuations in output
and employment—large variations in the sales
of new cars. I thought that illiquidity, due to
the fact that sellers of used cars know more than
the buyers of used cars, might explain the high volatility of automobile purchases.

In trying to make such a macroeconomic model, I got diverted. I discovered that the informational problems
that exist in the used car market were potentially present to some degree in all markets. In some markets, asymmetric information is fairly easily soluble by repeat sale and by reputation. In other markets, such as insurance markets, credit markets, and the market for labor, asymmetric information between buyers
and sellers is not easily soluble and results in
serious market breakdowns.

For example, the elderly have a hard time getting health insurance; small businesses are likely to be creditrationed; and minorities are likely to experience
statistical discrimination in the labor market because people are lumped together into categories of those with similar observable traits.

The failure of credit markets is one of the major reasons for underdevelopment. Even where mechanisms such as reputation and repeat sales arise to overcome the problem of asymmetric information, such institutions become a major determinant of market structure. To understand the origins of the economics of asymmetric information in markets, it is useful to reflect on the more general intellectual revolution that was occurring at the time. Prior to the early 1960’s, economic theorists rarely constructed models customized to capture unique institutions or specific market characteristics. Edward Chamberlin’s monopolistic competition and Joan Robinson’s equivalent were taught in graduate and even a few undergraduate courses.

However, such “specific” models were the rare exception; they were presented not as central sights, but instead as excursions into the countryside, for the adventurous or those with an extra day to spare. During the early 1960’s, however, “special” models began to proliferate as growth theorists, working slightly outside the norms of standard price-theoretic economics, began to construct models with specialized technological features: putty-clay, vintage capital, and learning by doing. The incorporation into models of such specialized technologies violated no established pricetheoretic norm, but it sowed the seed for the revolution that was to come.
During the summer of 1969, I first heard the word model used as a verb, and not just as a noun. It is no coincidence that just a few months earlier “The Market
for ‘Lemons’ ” had been accepted for publication. The “modeling” of asymmetric information in markets was to price theory what the “modeling” of putty-clay, vintage capital, and learning by doing had been to growth theory. It was the first application of a new economic orientation in which models are constructed with careful attention to realistic microeconomic detail.

This development has brought economic theory much closer to the fine grain of economic reality. Almost inevitably, the analysis of information asymmetries was the first fruit of this new modeling orientation. It
was the ripest fruit for picking. In the remainder of this essay I shall discuss the payoffs of this new orientation for the new field of behavioral macroeconomics.