Screening (economics)

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Screening in economics refers to a strategy of combating adverse selection – one of the potential decision-making complications in cases of asymmetric information – by the agent(s) with less information.

For the purposes of screening, asymmetric information cases assume two economic agents, with agents attempting to engage in some sort of transaction. There often exists a long-term relationship between the two agents, though that qualifier is not necessary. Fundamentally, the strategy involved with screening comprises the “screener” (the agent with less information) attempting to gain further insight or knowledge into private information that the other economic agent possesses which is initially unknown to the screener before the transaction takes place. In gathering such information, the information asymmetry between the two agents is reduced, meaning that the screening agent can then make more informed decisions when partaking in the transaction.[1]

Screening is applied in a number of industries and markets. The exact type of information intended to be revealed by the screener ranges widely; the actual screening process implemented depends on the nature of the transaction taking place. Often it is closely connected with the future relationship between the two agents.[1]

The concept of screening was first developed by Michael Spence (1973).[2] It should be distinguished from signalling – a strategy of combating adverse selection undertaken by the agent(s) with more information.

Examples[]

Labour market[]

Screening techniques are employed within the labour market during the hiring and recruitment stage of a job application process. In brief, the hiring party (agent with less information) attempts to reveal more about the characteristics of potential job candidates (agents with more information) so as to make the most optimal choice in recruiting a worker for the role.[3]

Interviews are a key screening technique used by hiring parties in a job recruitment process.

Screening techniques include:[3]

  • Application review – the hiring party initially screens applicants by undertaking a review of their application submission and any responses received, including an evaluation of their resume and cover letter to reveal education, experience and fit for the role
  • Aptitude testing and assessment – the hiring party may require applicants to undertake a range of testing exercises (either online or in-person) to reveal academic or practical abilities
  • Interviews – candidates are often required to undertake an interview with a representative(s) from the hiring party to reveal a range of factors such as personality traits, verbal communication ability and confidence level

Insurance market[]

The process of screening customers is highly applicable in the market for insurance. In general, parties providing insurance perform such activities to reveal the overall risk level of a customer, and as such, the likelihood that they will file for a claim. When in possession of this information, the insuring party can ensure a suitable form of cover (i.e. commensurate with the customer’s risk level) is provided.[4]

Screening techniques include:[4]

  • Background check – the party providing insurance obtains information about the customer such as their criminal history, credit rating and previous employment to reveal past behaviors
  • Provision of demographic information – the party providing insurance obtains information about the customer such as their age, gender and ethnicity to reveal their type

Other information gathered by insurance parties during a screening process is usually specific to the type of insurance the customer is seeking. For example, car insurance will require provision of accident history, health insurance will require provision of health condition and previous illnesses, and so on.

Other techniques[]

Second-degree price discrimination is also an example of screening, whereby a seller offers a menu of options and the buyer's choice reveals their private information. Specifically, such a strategy attempts to reveal more information about a buyer’s willingness to pay. For example, an airline offering economy, premium economy, business and first class tickets reveals information regarding the amount the customer is willing to spend on their airfare. With such information, firms can capture a greater portion of total market surplus.[5]

Contract theory[]

In contract theory, the terms "screening models" and "adverse selection models" are often used interchangeably.[6] An agent has private information about his type (e.g., his costs or his valuation of a good) before the principal makes a contract offer. The principal will then offer a menu of contracts in order to separate the different types. Typically, the best type will trade the same amount as in the first-best benchmark solution (which would be attained under complete information), a property known as "no distortion at the top". All other types typically trade less than in the first-best solution (i.e., there is a "downward distortion" of the trade level).[7]

Optimal auction design (more generally known as Bayesian mechanism design) can be seen as a multi-agent version of the basic screening model.[8][9] Contract-theoretic screening models have been pioneered by Roger Myerson and Eric Maskin. They have been extended in various directions. For example, it has been shown that, in the context of patent licensing, optimal screening contracts may actually yield too much trade compared to the first-best solution.[10] Applications of screening models include regulation,[11] public procurement,[12] and monopolistic price discrimination.[13] Contract-theoretic screening models have been successfully tested in laboratory experiments and using field data.[14][15]

See also[]

References[]

  1. ^ a b Stiglitz, Joseph E. (1975). "The Theory of "Screening," Education, and the Distribution of Income". The American Economic Review. 65 (3): 283–300. ISSN 0002-8282.
  2. ^ Spence, A. M. (1973). "Job Market Signaling". Quarterly Journal of Economics. 87 (3): 355–374. doi:10.2307/1882010. JSTOR 1882010.
  3. ^ a b Stiglitz, J.; Weiss, A. (1983). "Alternative Approaches to Analyzing Markets with Asymmetric Information: Reply". The American Economic Review. 73 (1): 246–249. ISSN 0002-8282.
  4. ^ a b Chiappori, Pierre‐Andre; Salanie, Bernard (2000). "Testing for Asymmetric Information in Insurance Markets". Journal of Political Economy. 108 (1): 56–78. doi:10.1086/262111. ISSN 0022-3808.
  5. ^ Dana, Jr., James D. (1998). "Advance‐Purchase Discounts and Price Discrimination in Competitive Markets". Journal of Political Economy. 106 (2): 395–422. doi:10.1086/250014. ISSN 0022-3808.
  6. ^ Laffont, Jean-Jacques; Martimort, David (2002). The theory of incentives: The principal-agent model. Princeton University Press.
  7. ^ Fudenberg, Drew; Tirole, Jean (1991). Game theory. MIT Press. Chapter 7.
  8. ^ Myerson, Roger B. (1981). "Optimal Auction Design". Mathematics of Operations Research. 6 (1): 58–73. doi:10.1287/moor.6.1.58. ISSN 0364-765X.
  9. ^ Bulow, Jeremy; Roberts, John (1989). "The Simple Economics of Optimal Auctions". Journal of Political Economy. 97 (5): 1060–1090. doi:10.1086/261643.
  10. ^ Schmitz, Patrick W. (2002). "On Monopolistic Licensing Strategies under Asymmetric Information" (PDF). Journal of Economic Theory. 106 (1): 177–189. doi:10.1006/jeth.2001.2863.
  11. ^ Baron, David P.; Myerson, Roger B. (1982). "Regulating a Monopolist with Unknown Costs". Econometrica. 50 (4): 911. CiteSeerX 10.1.1.407.6185. doi:10.2307/1912769. JSTOR 1912769.
  12. ^ Laffont, Jean-Jacques; Tirole, Jean (1993). A theory of incentives in procurement and regulation. MIT Press.
  13. ^ Maskin, Eric; Riley, John (1984). "Monopoly with incomplete information". RAND Journal of Economics. 15 (2): 171–196. doi:10.2307/2555674. JSTOR 2555674.
  14. ^ Hoppe, Eva I.; Schmitz, Patrick W. (2015). "Do sellers offer menus of contracts to separate buyer types? An experimental test of adverse selection theory". Games and Economic Behavior. 89: 17–33. doi:10.1016/j.geb.2014.11.001.
  15. ^ Chiappori, Pierre-Andre; Salanie, Bernard (2002). "Testing Contract Theory: A Survey of Some Recent Work". Rochester, NY. SSRN 318780. Cite journal requires |journal= (help)
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