Abstract
We relax the common assumption of homogeneous beliefs in principal-agent relationships with adverse selection. Principals are competitors in the product market and write contracts also on the base of an expected aggregate. The model is a version of a cobweb model. In an evolutionary learning set-up, which is imitative, principals can have different beliefs about the distribution of agents’ types in the population. The resulting nonlinear dynamic system is studied. Convergence to a uniform belief depends on the relative size of the bias in beliefs.
Highlights
In mechanism design it is assumed that players have a subjective probability distribution over a set of possible elements or outcomes, which represents information privately known to other players
We study imitation equilibria in this market characterized by adverse selection and heterogeneous beliefs
All findings presented so far will be symmetrically reversed, as well. This implies, for example, for one of the main results in Theorem 1 that there exists a level of pessimism below which the population converges to an unbiased equilibrium
Summary
In mechanism design it is assumed that players have a subjective probability distribution over a set of possible elements or outcomes, which represents information privately known to other players. Principals offer contracts based on the expected aggregate quantity and their belief over the distribution of types in the economy. We are interested in the way that a bias can affect that externality and, in a feedback effect, how the externality affects the bias This means that, on the one hand, and this is to be expected, firms acting on biased beliefs influence the aggregate quantity in the market, because their individual output decisions are changed by the bias. Starting with Festinger [9], psychologists point out that individuals tend to carry out “social comparisons” preferably (but not exclusively) with similar others The latter point suggests that our principals treat information gained from different reference groups differently.
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