[skip to content]

Centre for Financial and Management Studies (CeFiMS)

Modelling Firms & Markets

Course Code:
C358
Unit value:

Introduction

Modelling Firms and Markets is an introduction to the economics of information and uncertainty. Multi-person decision problems play a crucial role in industrial economics. This course begins with the basic concepts of game theory - the problems of decision-making under a multi-person environment. We will then examine the problems of private information and analyse the role of asymmetric information in market interactions, in particular the problems known as moral hazard (hidden actions) and adverse selection (hidden characteristics) under various economics contexts. You will learn how these informational problems affect the market outcome and if they lead to market inefficiencies, and if so, possible solutions.

Resources

Study Guide

You will receive a looseleaf binder containing eight 'course units'. The units are carefully structured to provide the main teaching, defining and exploring the main concepts and issues, locating these within current debate and introducing and linking the further assigned readings. The unit files are also available to download from the Online Study Centre.

Textbooks
  • Robert Gibbons (1992) A Primer in Game Theory, Harvester Wheatsheaf.
  • Donald E. Campbell (2006) Incentives: Motivation and the Economics of Information, (2nd ed.), Cambridge University Press.

In addition to the course guide, a collection of articles from other sources will be provided in a Course Reader.

Online Study Centre

You will have access to the OSC, which is a web-accessed learning environment. Via the OSC, you can communicate with your assigned academic tutor, administrators and other students on the course using discussion forums. The OSC also provides access to the course Study Guide and assignments, as well as a selection of electronic journals available on the University of London Online Library.

Objectives and learning outcomes of the course

By the end of this course you will be able to:

  • explain the basic equilibrium concepts such as Nash equilibrium (pure and mixed)
  • apply Nash equilibrium in oligopoly competition (Cournot & Bertrand); solve simple repeated games using backward induction and define subgame perfect equilibrium
  • identify the concept of a Bayesian game and find its equilibrium
  • define perfect Bayesian equilibrium and explain the signaling problem
  • apply the concepts of adverse selection and moral hazard in different microeconomic contexts and
  • explain how risk and information asymmetry affect the efficiency of contracting;
  • acquire important knowledge on the role of incentives and optimal contracting in addressing this issue related to asymmetric information
  • be familiar with various types of auctions and the Revenue Equivalence principle
  • discuss general competitive equilibrium and its application

Scope and syllabus

Course Units
Unit 1: Static Games of Complete Information
  • 1.1 Normal (Strategic) Form Game and Iterated Deletion
  • 1.2 Nash Equilibrium
  • 1.3 Mixed-Strategy Nash Equilibrium
  • 1.4 Existence of Nash Equilibrium
  • 1.5 Applications of Nash Equilibrium
  • 1.6 Conclusion
Unit 2: Dynamic Games of Complete Information
  • 2.1 Dynamic Games of Complete and Perfect Information
  • 2.2 Subgame Perfection - Generalisation of the Backwards Induction
  • 2.3 Repeated Games
  • 2.4 Conclusions
Unit 3: Static Games of Incomplete Information
  • 3.1 Cournot Competition of Incomplete Information
  • 3.2 Normal-Form Representation of Static Bayesian Games and Bayesian Nash Equilibrium
  • 3.3 Applications
  • 3.4 The Revalation Principle
  • 3.5 Conclusion
Unit 4: Dynamic Games of Incomplete Information
  • 4.1 Perfect Bayesian Equilibrium
  • 4.2 Application
  • 4.3 Refinements of Perfect Bayesian Equilibrium
  • 4.4 Conclusion
Unit 5: Hidden Action (Moral Hazard)
  • 5.1 Introduction
  • 5.2 Examples of the Hidden Action Problems
  • 5.3 Moral Hazard and Insurance
  • 5.4 Principal–Agent Problem: the Model and Optimal Wage Contract
  • 5.5 Conclusion
Unit 6: Hidden Characteristics (Adverse Selection)
  • 6.1 Responding to Hidden Information - Price Discrimination
  • 6.2 Sellers with Private Information - the Market for Lemons
  • 6.3 Credit Rationing and the Stiglitz-Weiss Model
  • 6.4 Bundling and Product Quality
  • 6.5 Adverse Selection and Insurance
  • 6.6 Conclusion
Unit 7: Auctions
  • 7.1 Four Types of Auctions
  • 7.2 Outcome Equivalence for Private Value Auctions
  • 7.3 Sealed-Bid Auction
  • 7.4 Revenue Equivalence
  • 7.5 Common Value Auctions
  • 7.6 Conclusion
Unit 8: General Competitive Equilibrium
  • 8.1 General Equilibrium in a Pure Exchange Economy
  • 8.2 The Arrow-Debreu Model
  • 8.3 The Fundamental Theorems of Welfare Economics
  • 8.4 Externality
  • 8.5 The Issue of Convexity
  • 8.6 Common Property Resources
  • 8.7 Conclusion

Method of assessment

You will complete two assignments, which will be marked by your course tutor. Assignments are each worth 15% of your total mark. You will be expected to submit your first assignment by the Tuesday of Week 5, and the second assignment at the end of the course, on the Tuesday after Week 8. Assignments are submitted and feedback given online. In addition, queries and problems can be answered through the Online Study Centre. You will also sit a three-hour examination on a specified date in October, worth 70% of your total mark. An up-to-date timetable of examinations is published in April of each year.