Signaling Games
Microeconomics C
Session #4
Amine Ouazad
Outline
1.
2.
3.
4.
Education as a signal
What characterizes a signaling mechanism?
Warranties as a signal
Beer and quiche: Strategic Moves as Signals
Education as a signal
• What if students do not learn during their
degree?
– The three values of education: consumption value
(Lazear 1975), human capital accumulation (Becker
1964), signaling value (Spence 1973).
• Signaling value:
– On the labor market, candidates know more about
their productivity than potential employers,
information is asymmetric.
– Education is a costly enterprise, which is undertaken
only by high productivity individuals.
– Cost: opportunity cost of the degree, tuition fees, and
other costs.
• Intuition:
– With higher risks of failure, and higher time spent
investing in
Signaling model
• Simplify reality to gain insights.
• Two types of job candidates:
high and low productivity, noted H and L.
– Fraction p of high productivity candidates in
population.
• Asymmetric information: candidate knows his
type, but employer does not observe it.
Signaling model
• At a separating equilibrium,
– Wh – eh > Wl
– Wh – el < Wl
High productivity ind. get education
Low productivity ind. do not get educ.
• At a pooling equilibrium,
– pWh+(1-p)Wl – eh > Wl. High prod. ind. get educ.
– pWh+(1-p)Wl – el > Wl. Low prod. ind. Get educ.
– And somebody who is not educated is seen as lowproductivity by employers.
• Remarks:
– This is a Perfect Bayesian Equilibrium of the sequential
game.
– The candidate’s productivity is unaffected by
education. Education only serves as a costly signal.
Empirical evidence
Human capital augmentation versus the signaling value of MBA education,
Economics of Education Review, August 2012
Andrew Hussey
Abstract
Panel data on MBA graduates is used in an attempt to empirically distinguish between
human capital and signaling models of education. The existence of employment
observations prior to MBA enrollment allows for the control of unobserved ability or
selection into MBA programs (through the use of individual fixed effects). In addition,
variation in the amount of pre-MBA work experience allows for a test to distinguish
between the models. In particular, a predominant signaling view is shown to predict
smaller returns to the degree, the more pre-MBA work experience one has
(controlling for total experience). Additionally, a unique feature of the data is that
respondents were asked to report skills or abilities gained through their schooling,
allowing us to determine the extent to which these purported skills are valued in the
labor market. The combined evidence suggests that while human capital
accumulation may contribute to the returns to an MBA, the majority of the returns is
derived from the signaling/screening function of the degree.
Difference can also be on
the benefits’ side
Of the cost-benefit analysis.
• Signaling value of an MBA. It takes around 5 years to
recoup the cost of an INSEAD MBA. Women who
undertake an MBA are then more likely to stay at
least 5 years on the labor market after the MBA (and
empirically many do). The MBA convinces employers
that the candidate is committed to the labor market.
2. What characterizes
a signaling mechanism? (Abstract)
1. Asymmetric information.
2. The informed party chooses whether to invest in
a costly signal.
3. The uninformed party infers the agent’s type by
observing the costly signal in a separating
equilibrium.
4. The cost of the signal is higher for a highquality/high-productivity agent.
5. With some parameters, a pooling equilibrium
exists where every informed party invest in the
costly signal but the signal is uninformative.
3. Warranties as a signal
• Church’s “Consul” black leather shoes:
£350 a pair.
• It offers a full warranty. A worn out shoe is
replaced for free, including shipping costs to
Church’s workshops in England, as many times as
needed.
• Is this sufficient to convince the customer that
the shoe is of high quality?
– Marginal cost of an entire shoe: £200 (handmade in
Northampton).
– Cost of refitting the shoe on average £80.
– Customers buy a new model after 2 years on average.
3. Warranties as a signal
• Church wants to signal that the shoe is of
‘high-quality’, i.e. it will need no repair or at
most 1 repair in 2 years.
• Separating equilibrium:
– High quality shoe-makers offer the warranty:
ph – mc – (# of repairsh*cost)> pl – mc
– Low quality shoe-makers do not offer the
warranty:
pl – mc > ph – mc – (# of repairsl*cost)
• In a nutshell:
– It costs more for a low-quality shoe-maker to offer
the warranty – offering the warranty is not
profitable for the shoe-maker.
4. Beer and Quiche:
Strategic moves as signals
• Recap: the entry game.
– Sequential game.
– Entrant and incumbent.
• Uncertainty is about “toughness” or “softness” of
the incumbent.
• Can the tough incumbent signal his toughness by
making a move prior to the entry of the entrant?
– The cost of the signal has to be higher for the soft
incumbent than for the tough incumbent.
Signaling Toughness under Uncertainty
• The beer & quiche model
• An incumbent monopolist can be either tough or soft.
• Prior to the entrant’s decision to enter or stay out, the incumbent gets
to choose its “breakfast.” Specifically, the incumbent can have beer
for breakfast or quiche for breakfast. Breakfasts are consumed in
public.
• A beer breakfast is less desirable than a quiche breakfast.
• But costs differ according to type: a beer breakfast costs a tough
incumbent less than a wimp incumbent.
If Interested – Analyze This
enter
enter
1,-1
Incumbent
quiche
beer
3,0 out
tough
Entrant
[½]
Entrant
soft
enter
[½]
2,2
quiche
beer
1,0 out
out 4,0
Nature
enter
-1,2
2,-1
Incumbent
out 4,0
Beer & Quiche
•Equilibrium: Tough incumbent drinks beer; soft
incumbent eats quiche; entrant stays out against beer
drinkers; and entrant enters against quiche eaters.
•What are beer & quiche?
Toughness
Beer
Excess Capacity
High Output
Low Costs
Low Prices
Deep Pockets
Beat up Rivals &
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