Question

1.        The server of an internet provider’s (Zeus) computer system has failed. Without this component the system will not operate and the firm will earn no revenue until it is replaced. Zeus hires a courier company (Athena) to pick up the server, deliver it to a repair shop and return it the next day. Zeus has a guarantee from the repair shop that this is feasible. Athena undertakes to deliver the server and pick it up when repaired. However, Athena has no idea that this is a critical component and Athena charges the standard rate for this service. The server is returned many days later and, unbeknown to Athena, Zeus’s revenue has completely dried up. Zeus sues Athena for lost profit. Use a model of asymmetric information to describe and analyse this problem. Describe and discuss a rule of law might be applied in this case to encourage Zeus to reveal the importance of the server.

Answer 1

There is a problem of as asymmetric information here as Athena doesn't have complete information about the product to be repaired while the one who owns the product ( zeus in this case) has complete information about the quality.

Because of the asymetricity in the market, Athena charges an anverage price for the damaged product while it would have charged higher if there was complete information about the damaged product. This is more technically called as the problem of adverse selection.

Zeus should be encouraged to provide the information about the server by placing a system of mutual benefit which keeps the incentive of both parties alive which is also known as incentive compatibility