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- [Professor Tyler] So how did the Korean Hyundai
become such an excellent car,
and earn so much success in the marketplace?
Well, let's go back in time.
In 1986, the first Hyundai Excel was sold in the United States.
It was not entirely attractive, but it was inexpensive.
The problem though was that it just didn't work that well.
So Hyundais quickly developed a reputation
for being lower quality cars,
and in time, they became the butt of jokes among American consumers.
Jay Leno, who was at that time was host of the Tonight Show
said that you could double the value of your Hyundai
by filling it up with gas.
Hyundai wanted to flip this reputation
and compete with the more successful companies,
such as Honda and Toyota, and they managed.
Hyundai decided they would invest in new advanced factories,
in worker training, and in quality control.
This, in turn, would result in much higher quality cars.
But how could Hyundai convince consumers
of this new higher quality --
quality that was maybe difficult to see
unless you had owned the car for a few years already.
Consumers didn't, in fact, usually know what was going on
in Hyundai’s factories.
So again, we have a case of asymmetric information,
where Hyundai knew much more about the quality of its products
than did consumers.
So what could the company do?
Hyundai rolled out what it called "America's Best Warranty."
The warranty assured consumers that the cars were high quality,
and it got consumers to start buying those cars.
What's great about this idea
is that it doesn't actually cost Hyundai very much,
because the cars were in fact high quality
and they didn't need to be fixed all the time.
This Hyundai warranty is an example of a signal.
A signal is an expensive action that reveals information,
and for it to work, a signal has to be credible.
In this case, if Hyundai cars were still unreliable,
such a comprehensive warranty
would have been extremely costly to Hyundai.
Consumers, therefore, bought Hyundais
figuring that if the warranty were so strong,
well, the company had to have a lot of faith in its cars.
So how does a signal help alleviate asymmetric information?
Hyundai knew their cars were of high quality
but consumers didn't know.
The warranty was a credible signal
that conveyed information to the consumers,
specifically information about the quality under the hood,
that consumers otherwise couldn't easily judge.
This signal gave consumers the information necessary
to have enough confidence to buy a Hyundai.
Indeed, this story had a happy ending.
So where else might we see signaling?
Well, let's consider a puzzle in higher education.
If going to college was simply all about learning skills,
then you would expect that your expected wages
would steadily grow as you completed more and more classes.
For instance, when you would get halfway through with your degree,
you would get half of the expected wage increase
from earning the degree.
In each class, you're learning valuable skills
so your expected wages should incrementally rise
with each class completed, right?
Well, wrong.
In fact, a large fraction of the value of a degree
comes on the day you earn your degree, and finish.
So rather than seeing a steady increase
in your expected wage as you go through college,
you have a sharp upturn in that wage right at the end.
Again, when you finish.
This is called the "Sheepskin Effect,"
because diplomas used to be printed on sheepskin.
Additionally, we see people who receive a degree in,
say, Art History,
and they take jobs that maybe have little or nothing to do
with the history of art.
Yet these people receive higher wages
than those without a degree altogether.
Why?
Well, the learning of art history may not be applicable to the jobs,
but it shows those people have some kind of talent.
The signaling theory of education --
from Nobel Prize winner Michael Spence --
is that education is valuable,
not only because it teaches us things,
but also because it signals worker quality.
There’s asymmetric information
between an employee and a potential employer.
The employer doesn't know how smart, determined,
or conscientious you might be.
A degree provides a credible signal of these traits
and gives employers more information
about possible hires.
Why is it credible?
Well, getting a degree is harder for someone
who isn't as smart, determined, or conscientious.
Here are some other signals to think about.
Are diamond engagement rings
just about giving your loved one something beautiful?
Or is it also important that the ring costs a lot?
What asymmetric information might this signal help reveal?
Here's another one.
Why do some criminals tattoo their faces?
What might be the asymmetric information problems
that they're trying to solve?
And signaling is not only a human phenomenon.
Why does a peacock drag around a large colorful tail
which might appear to hinder its survival?
What kind of signal might be going on there?
And to whom?
Check your intuitions to these puzzles
in our practice questions after this video.
So, now that we've covered
how signals can help overcome asymmetric information,
you might wonder, "Are signals always a good thing?"
It might seem wasteful to spend four years at college,
or to spend two months’ salary on a ring just to signal something.
Students might prefer to learn more
rather than spending so much time jumping through hoops,
and it might be better to buy something more practical
for a potential spouse than just a ring.
While signals do create some inefficiency,
they also generate benefits by creating more information.
They help individuals in markets realize gains from trade
by overcoming problems of asymmetric information.
So if you've enjoyed this video --
well, give us a signal and please let us know.
Drop us a note or leave a suggestion for us.
Your feedback will help determine
how we produce future videos and materials.
Thanks.
- [Narrator] If you want to test yourself,
click "Practice Questions."
Or, if you're ready to move on, just click "Next Video."
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