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July 19, 2018 

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LEADING ECONOMIC INDICATOR: One of eleven economic statistics that tend to move up or down a few months before the expansions and contractions of the business cycle. These leading indicators are -- manufacturers new orders, an index of vendor performance, orders for plant and equipment, Standard & Poor's 500 index of stock prices, new building permits, durable goods manufacturers unfilled orders, the money supply, change in materials prices, average workweek in manufacturing, changes in business and consumer credit, a consumer confidence index, and initial claims for unemployment insurance. Leading indicators indicate what the aggregate economy is likely to do, business-cycle-wise, 3 to 12 months down the road. When leading indicators rise today, then the rest of the economy is likely to rise in the coming year. And when leading indicators decline, then the economy is likely to decline in 3 to 12 months.

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SCREENING:

When confronted by asymmetric information, the use of small bits of information, or indicators, that suggest more comprehensive information. Screening occurs when those with limited information try to identify indicators suggesting more complete information. It is used in markets with adverse selection and moral hazard, especially in labor markets and in the provision of insurance. Common methods of screening include aptitude tests, affiliations, past behavior, and personal characteristics. A related method is signalling.
Screening is one method of addressing the problems associated with asymmetric information, especially adverse selection and moral hazard. When asymmetric information creates inefficiency because one side of a market has less information that the other, screening can be used to enhance the flow of information. Those with less information use a variety of methods to screen out those of higher quality from those of lesser. Common screening methods include aptitude tests, grade point averages, school affiliations, historical records and demographic characteristics.

Two markets that regularly make use of screening are the labor market and the provision of insurance. Adverse selection can limit the quality of workers hired by employers in the labor market and moral hazard creates inefficiency in the provision of insurance. Low information employers often screen potential employees through aptitude tests, grade point averages, and school affiliations. Low information insurance providers often screen customers using historical records and demographic characteristics. In both cases, those with less information use small bits of easily obtained information to indicate more complete information.

Screening can be an effective, but imperfect way of addressing asymmetric information. Unfortunately because screening by its very nature is based on limited information, it can let low quality products slip into the high quality group (in the case of adverse selection) and it need not accurately indicate a change in behavior (in the case of moral hazard). If screening fails to indicate accurate information, then it doesn't work.

Signalling is a related method of addressing the problems of asymmetric information. Signalling arises when those with more information provide indicators to differentiate product quality. Whereas screening is used by those with less information, signaling is undertaken by those with more.

Asymmetric Information

Asymmetric information exists because information is not equally available to everyone. Some people are bound to know more than others. In particular, information is likely to be unbalanced or asymmetrically available to buyers and sellers in a market. Sellers, who have possession of a good, often have more information than buyers.

Screening is used when asymmetric information leads to adverse selection and moral hazard.

  • Adverse Selection: One important consequence of asymmetric information is adverse selection, which arises when the lack of information limits the quality of goods exchanged. Because buyers have less accurate information about the quality of goods, they are likely to offer a lower price, which discourages sellers from offering higher quality goods. Screening is used in labor markets with adverse selection

  • Moral Hazard: Asymmetric information also leads to moral hazard, which arises when one person makes a decision that harms another. The best example is found with insurance in which an insured person undertakes risky behavior knowing the insurance provider incurs the cost. The problem is that the insurance provider is unaware of the risky actions of the insured person. Screening can be used to inform the insurance provider about the change in behavior.
The way to correct adverse selection and moral hazard is to provide more information. Unfortunately, the some have less information is that an efficient search balance between the benefits and costs don't justify more. Screening addresses this by providing low cost of information. The information is not as good nor is it as complete, but it is better.

Common Screening Techniques: Labor

A wide variety of screening techniques can be used to address the problems of asymmetric information. First up is a short list used in the labor market followed by a list used in the provision of insurance.
  • Aptitude Tests: Scores achieved by potential employees on standardized or specialized tests are often used by employees to screen out higher quality workers from lower quality ones. Presumably these test scores indicate worker productivity.

  • Grade Point Average: Similar to aptitude tests, grade point average achieved through years of schooling is also used to differentiate among potential employees. In contrast to a single test, grade point reflects performance over several years.

  • School Affiliations: Employers also look to quality of the school a student attends as a screening technique. Presumably higher quality schools produce higher quality students and workers.

  • Extra Curricular Activity: Another screening technique is noncourse related clubs and other activities. Those who undertake and do well in these activities are usually presumed to possess desired work qualities.

Common Screening Techniques: Insurance

The moral hazard problems associated by the provision of insurance are addressed with a number of screening techniques:
  • Historical Record: Insurance provides use past behavior as an indication of risk and future behavior. A driver with a history of car accidents is more likely to have accidents in the future. A person who has had health problems in the past is more likely to have health problems in the future.

  • Demographic Characteristics: Another screening technique used by insurance providers is demographic characteristics. For example, a young male between the ages of 16 and 19 might be more likely to have a car accident than a middle-aged woman between the ages of 45 and 50.

Incorrect Screens

To the extent that screening is based on incomplete information it can incorrectly screen high quality from low. An otherwise excellent and productive worker just might not perform well on aptitude tests or achieve high course grades or have attended a "good" school or pursued extra curricular activities. In contrast, an unproductive worker might perform well on aptitude tests, achieved high course grades, attended a "good" school, and pursued extra curricular activities.

A excellent driver, who will never again have an accident, might have had the misfortune of making a couple of mistakes and exist in the "wrong" demographic group. A very bad driver, in contrast, might be in the "right" demographic group and be extremely fortunate to have avoided previous accidents.

Signalling

Another technique used to counter the problems of asymmetric information is signalling. Signalling occurs when those with more information pass along bits of information that indicate more complete information. Automobile companies, for example, commonly use advertising, warranties, and technical specifications as a means of signaling the (presumably high) quality of their products.

Whereas screening is a low cost means of used by those with low information to find out more, signalling works in the opposite way. It is a means by which those with more information pass along information from those with less.

When asymmetric information limits the exchange of higher quality products, such as that illustrated by the market for lemons, those who supply these products seek to provide low cost bits of information to the buyers. Because the buyers cannot justify the expense of searching out the information, the sellers offer low cost information signals through such things as advertising, brand name recognition, warranties, and guaranties.

Signals can be an effective, but imperfect way of addressing adverse selection. Unfortunately those selling lower quality products often try to mimic these signals. This confuses the situation and reduces the effectiveness of signalling. If signals fail to differentiate high quality goods from low, then they don't work.

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Recommended Citation:

SCREENING, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2018. [Accessed: July 19, 2018].


Check Out These Related Terms...

     | signalling | adverse selection | economics of information | information | information search | asymmetric information | moral hazard | principal-agent problem | rational ignorance | market for lemons |


Or For A Little Background...

     | scarcity | efficiency | sixth rule of ignorance | production | consumption | opportunity cost | scarce resources | market |


And For Further Study...

     | public choice | innovation | good types | market failures | financial markets | institutions | rational abstention | risk | uncertainty | risk preferences | risk aversion | risk neutrality | risk loving | marginal utility of income |


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