Reference no: EM133131999
Consider the following situation of asymmetric information for two parties in a civil trial. Assume that a plaintiff has private information about the level of harm (A) they have suffered from an accident. The defendant doesn't know exactly how much harm has been incurred but has the following beliefs:
A = 500 with probability p. (Call this type of plaintiff 'L-type') = 1200 with probability (1-p) (call this plaintiff a 'H-type)
Assume that if the case goes to trial the judge will award the correct level of damages. Further assume that court costs for the plaintiff and the defendant are equal to 100, That is: cp = cd = 100.
Consider what happens in the absence of information exchange.
What is the minimum offer that could be made and accepted if the plaintiff is an L-type? What is the defendants expected cost if they make such an offer given they do not actually know the type of plaintiff they face? Call this strategy (a).
What is the minimum offer that could be made and accepted if the plaintiff is an H-type? What is the defendants expected cost if they make such an offer given they do not actually know the type of plaintiff they face? Call this strategy (b)
If the defendant is risk neutral identify the circumstances when they will adopt strategy (a) rather than strategy (b). Hint: Your answer should be a function of p.
What are the expected court costs if strategy (a) rather than strategy (b) is chosen?
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