Question 1

Which of the following would be LEAST likely to contribute to a moral hazard problem among drivers?

Accepted Answer

A)  Provide medical coverage to all drivers, their passengers, and any and all individuals involved in the accident, no matter who was at fault. 
B)  Provide medical coverage and car repair/replacement coverage to drivers, their passengers, and any and all individuals involved in the accident, no matter who was at fault. 
C)  Modify all cars to remove the driver's seatbelt and the steering wheel air bag. 
D)  Pass a law limiting the amount of damages that juries may award in accident cases. 
E)  Make automobile insurance mandatory for all drivers. 
A)  Provide medical coverage to all drivers, their passengers, and any and all individuals involved in the accident, no matter who was at fault. 
B)  Provide medical coverage and car repair/replacement coverage to drivers, their passengers, and any and all individuals involved in the accident, no matter who was at fault. 
C)  Modify all cars to remove the driver's seatbelt and the steering wheel air bag. 
D)  Pass a law limiting the amount of damages that juries may award in accident cases. 
E)  Make automobile insurance mandatory for all drivers.

Question 2

Some firms provide stock options to managers as an incentive to work hard and increase the value of the firm. A typical option contract gives the manager the right to buy the firm's stock at a set price (known as the exercise price). If the firm's stock value increases and moves above the exercise price, then the manager's option becomes more valuable. What is the potential problem with this incentive scheme?

Accepted Answer

A)  The incentive does not include a performance benchmark, so it cannot be optimal. 
B)  There is a dynamic incentive problem --- the manager may focus too much on the firm's short-run stock value and not on actions that are in the best interest of the firm for the long run. 
C)  The incentive value depends on the firm's stock value, which cannot be influenced by the amount of work or effort exerted by the manager. 
D)  There are no problems with this incentive scheme. 
A)  The incentive does not include a performance benchmark, so it cannot be optimal. 
B)  There is a dynamic incentive problem --- the manager may focus too much on the firm's short-run stock value and not on actions that are in the best interest of the firm for the long run. 
C)  The incentive value depends on the firm's stock value, which cannot be influenced by the amount of work or effort exerted by the manager. 
D)  There are no problems with this incentive scheme.

Question 3

Scenario 17.2
Consider the information below:
For Group K the cost of attaining an educational level y is
CS1U1B1KS1U1B0(y) = $2,000y
and for Group M the cost of attaining that level is
CS1U1B1MS1U1B0(y) = $4,000y.
Employees will be offered $30,000 if they have y    .
-Refer to Scenario 17.2. If the threshold educational level y* is set at 13 1/3,

Accepted Answer

A)  only individuals in Group K will attain it. 
B)  only individuals in Group M will attain it. 
C)  individuals in both groups will attain it. 
D)  no individuals will attain it. 
E)  some fraction of individuals in each group will attain it. 
A)  only individuals in Group K will attain it. 
B)  only individuals in Group M will attain it. 
C)  individuals in both groups will attain it. 
D)  no individuals will attain it. 
E)  some fraction of individuals in each group will attain it.

Question 4

What is the problem with paying plant managers in multi-plant firms according to the level of output they produce?

Accepted Answer

A)  Managers in low-cost or high-capacity plants could be penalized, in percentage terms, for their overproduction. 
B)  The production problem in multi-plant firms is usually how to lower production to increase market power, not how to increase production. 
C)  Managers in high-cost or low-capacity plants could be penalized for production constraints over which they have no control. 
D)  Managers would have an incentive to understate the productive capacity of their plants. 
E)  Managers would have an incentive to overstate the productive capacity of their plants. 
A)  Managers in low-cost or high-capacity plants could be penalized, in percentage terms, for their overproduction. 
B)  The production problem in multi-plant firms is usually how to lower production to increase market power, not how to increase production. 
C)  Managers in high-cost or low-capacity plants could be penalized for production constraints over which they have no control. 
D)  Managers would have an incentive to understate the productive capacity of their plants. 
E)  Managers would have an incentive to overstate the productive capacity of their plants.

Question 5

The process by which sellers send signals to buyers conveying information about product quality is known as:

Accepted Answer

A)  asymmetric information. 
B)  market signaling. 
C)  a lemons problem. 
D)  moral hazard. 
A)  asymmetric information. 
B)  market signaling. 
C)  a lemons problem. 
D)  moral hazard.

Question 6

Matthew drives a truck for Overtheroad Haulers. Matthew's marginal benefit for driving per day is: MB(m) = 2,400 - 2m, where m is the number of miles driven. The marginal social cost per mile is MSC(m) = 2m. Calculate the efficient number of miles driven for Matthew in a day. Since Overtheroad Haulers has full insurance on Matthew's truck, Matthew's personal marginal cost is: MPC(m) = m. How many miles per day will Matthew drive? Would it be efficient for society if Overtheroad Haulers places a limit on the number of miles Matthew drives? If so, what limit should they set?

Accepted Answer

Efficiency requires: MB(m) = MSC(m) @#LAT-DLM& 2,4

Question 7

The principal-agent problem of ownership vs. control of the corporation arises when owners and managers

Accepted Answer

A)  are the same people. 
B)  pursue objectives that differ from those their customers wish them to pursue. 
C)  pursue objectives that differ from those their workers wish them to pursue. 
D)  pursue objectives that differ from those the government wishes them to pursue. 
E)  pursue different objectives. 
A)  are the same people. 
B)  pursue objectives that differ from those their customers wish them to pursue. 
C)  pursue objectives that differ from those their workers wish them to pursue. 
D)  pursue objectives that differ from those the government wishes them to pursue. 
E)  pursue different objectives.

Question 8

Cecil's Home Appliances sells high quality washing machines. Cecil's marginal cost function is:
MCC(QC) =   
. Zach's Appliances sells low quality washing machines. Zach's marginal cost function is: MCC(QZ) =   
. The market demand for high quality washing machines is:   
= 8,250 - 10PH. The market demand for low quality washing machines is:   
= 5,000 - 10PL. If Consumer's can distinguish between the quality of Cecil's and Zach's machines (and Cecil and Zach behave as price takers), determine the equilibrium price of washing machines. Calculate Cecil's producer surplus. Now, suppose that consumers can not distinguish between the quality of Cecil's and Zach's washing machines. In this case, the demand for washing machines is: QD = 6,625 - 10P. Determine the joint market supply curve. Calculate the equilibrium price of washing machines and the quantity brought to market by Cecil and Zach. What is Cecil's producer surplus? If Cecil offers a warranty on his washing machines, his marginal cost function becomes: MCC(   
) =   
. However, consumers will then perceive his machines to be high quality. Should Cecil offer the warranty?

Accepted Answer

In the high quality market, Cecil sets:

Question 9

The problem of adverse selection in health insurance leads to a situation in which

Accepted Answer

A)  health insurance covers inappropriate items for the population it serves. 
B)  overinsurance of the premium-paying population occurs. 
C)  underinsurance of the premium-paying population occurs. 
D)  the percentage of the premium-paying population that is healthy rises, squeezing unhealthy individuals out of the market. 
E)  the percentage of the premium-paying population that is unhealthy rises, squeezing healthy individuals out of the market. 
A)  health insurance covers inappropriate items for the population it serves. 
B)  overinsurance of the premium-paying population occurs. 
C)  underinsurance of the premium-paying population occurs. 
D)  the percentage of the premium-paying population that is healthy rises, squeezing unhealthy individuals out of the market. 
E)  the percentage of the premium-paying population that is unhealthy rises, squeezing healthy individuals out of the market.

Question 10

In this problem, a labor market exists where employers hire and pay workers according to how much formal education workers possess. Education is a proxy for the level of productivity that employers can expect from workers. Therefore, employers follow a strategy in which they hire workers and pay salaries according to the following conditions:
Degrees Above the Values of Post High School
High School Level Education During Working Life, B(y)
None 0
(y = 0 years)
Associate's Degree $30,000
(y = 2 years)
Bachelor's Degree $51,000
(y = 4 years)
Master's Degree $58,000
(y = 6 years)
Assume that there are only two types of worker abilities, those who are less productive (type L) and those who are highly productive (type H). The less productive workers have to study harder than highly productive workers in order to earn any degree. Consequently, the costs (including the psychic costs of study effort) of attaining various levels of education for these two types of employees are different.
For less productive workers: CL(y) = $13,000y
For highly productive workers: CH(y) = $10,000y
a. Draw a diagram with years of education on the horizontal axis. Graph the benefits to education B(y) and the costs of education for each of the two types of workers. Discuss what level of education each type of worker should obtain.
b. Now use the equations above to verify your answer from part (a) mathematically.
c. Explain the value of formal education above the high school level in the market place to employers.

Accepted Answer

a.
As shown in this figure, the benefits

Question 11

Ron owns an automotive repair center. Ron provides high quality automotive repair. The market price for high quality service is $225 while the market price for standard service is $150. Currently, Ron only has a reputation for providing standard service. Ron's marginal cost function of providing high quality service is: MCH(Q) = 0.25Q. Ron's marginal cost function of providing standard service is: MCS(Q) = 0.0625Q. Butch's Marketing has told Ron that if he hires Butch's firm to advertise and market Ron's high quality services, consumers will pay him the high quality service market price providing he delivers that quality. What is the most amount of money Ron is willing to pay for Butch's services?

Accepted Answer

If Ron can sell his high quality service

Question 12

The problem of production in multi-plant firms with asymmetric information can be solved by paying the manager

Accepted Answer

A)  a piece rate, some constant amount per unit of output produced. 
B)  a larger amount for each unit than was paid for the previous unit, to reflect increasing marginal cost. 
C)  a smaller amount for each unit than was paid for the previous unit, to reflect decreasing marginal revenue. 
D)  an annual bonus that increases with each unit of output up to capacity, and decreases with each unit of output past capacity. 
E)  an annual bonus that is calculated decreases with each unit of output up to capacity, and increases with each unit of output past capacity. 
A)  a piece rate, some constant amount per unit of output produced. 
B)  a larger amount for each unit than was paid for the previous unit, to reflect increasing marginal cost. 
C)  a smaller amount for each unit than was paid for the previous unit, to reflect decreasing marginal revenue. 
D)  an annual bonus that increases with each unit of output up to capacity, and decreases with each unit of output past capacity. 
E)  an annual bonus that is calculated decreases with each unit of output up to capacity, and increases with each unit of output past capacity.

Question 13

Suppose new electronic devices make it easier to monitor the effort levels of workers. If some shirking is still possible in the efficiency wage model, what happens to the efficiency wage?

Accepted Answer

A)  Declines, but remains above the market-clearing wage 
B)  Declines, and falls below the market-clearing wage 
C)  Increases 
D)  Does not change 
A)  Declines, but remains above the market-clearing wage 
B)  Declines, and falls below the market-clearing wage 
C)  Increases 
D)  Does not change

Question 14

Scenario 17.3
Consider the following information:
The probability of a fire in a factory without a fire prevention program is 0.01. The probability of a fire in a factory with a fire protection program is 0.001. If a fire occurred, the value of the loss would be $300,000. A fire prevention program would cost $80 to run.
-Refer to Scenario 17.3. If the fire protection program were in place, the company could insure the warehouse for a premium equal to

Accepted Answer

A)  the loss from the fire, $300,000. 
B)  the expected loss from the fire, $300. 
C)  the expected loss from the fire, $3,000. 
D)  the cost of the fire protection program, $80. 
E)  $0. 
A)  the loss from the fire, $300,000. 
B)  the expected loss from the fire, $300. 
C)  the expected loss from the fire, $3,000. 
D)  the cost of the fire protection program, $80. 
E)  $0.

Question 15

Which incentive scheme would simultaneously elicit accurate information about feasible plant production levels and motivate managers to perform up to potential (in the following schemes, B is the bonus payment, Q is actual plant output, and Qf is the manager's estimate of feasible output)?

Accepted Answer

A)  B = 0.4Q 
B)  B = 0.4(Q - Qf) 
C)  B = 0.4Qf + 0.3(Q - Qf) if Q > Qf  
D)  B = 0.4Qf - 0.6(Q - Qf) if Q f  
E)  B = 0.4Qf - 0.6(Q - Qf) if Q > Qf  
A)  B = 0.4Q 
B)  B = 0.4(Q - Qf) 
C)  B = 0.4Qf + 0.3(Q - Qf) if Q > Qf  
D)  B = 0.4Qf - 0.6(Q - Qf) if Q f  
E)  B = 0.4Qf - 0.6(Q - Qf) if Q > Qf

Question 16

If grades are to be a successful signal to potential employers of a student's qualities, then higher grades must be

Accepted Answer

A)  easier for high-productivity students to earn than for low-productivity students to earn. 
B)  easier for low-productivity students to earn than for high-productivity students to earn. 
C)  easy for employers to check. 
D)  used for all future promotions within the firm. 
E)  often referred to in the hiring process. 
A)  easier for high-productivity students to earn than for low-productivity students to earn. 
B)  easier for low-productivity students to earn than for high-productivity students to earn. 
C)  easy for employers to check. 
D)  used for all future promotions within the firm. 
E)  often referred to in the hiring process.

Question 17

When asymmetric information problems drive high quality products from a market, we refer to this situation as:

Accepted Answer

A)  adverse selection. 
B)  moral hazard. 
C)  a lemons problem. 
D)  A and C are correct. 
E)  B and C are correct. 
A)  adverse selection. 
B)  moral hazard. 
C)  a lemons problem. 
D)  A and C are correct. 
E)  B and C are correct.

Question 18

In the economic literature on principal-agent problems, the ________ is the person who takes some action, and the ________ is the person whom the action affects.

Accepted Answer

A)  agent, principal 
B)  principal, agent 
C)  Both statements describe the agent. 
D)  Both statements describe the principal. 
A)  agent, principal 
B)  principal, agent 
C)  Both statements describe the agent. 
D)  Both statements describe the principal.

Question 19

Scenario 17.5
Consider the following information:
Income to the firm from workers who sell door-to-door
Bad Luck Good Luck
Low Effort (e = 0) $5,000 $7,000
High Effort (e = 1) $7,000 $13,000
Cost of effort: c = $2500e
Probabilities: Bad luck = .75; Good luck = .25
-Refer to Scenario 17.5. The owners can't know whether the workers are exerting high or low effort if income is

Accepted Answer

A)  $5000. 
B)  $7000. 
C)  above $7000. 
D)  $13,000. 
E)  above $13,000. 
A)  $5000. 
B)  $7000. 
C)  above $7000. 
D)  $13,000. 
E)  above $13,000.

Question 20

When states make car insurance mandatory for all drivers, it

Accepted Answer

A)  raises rates for everyone because it brings bad drivers into the pool. 
B)  raises rates for high-risk drivers. 
C)  may lower rates for all drivers to the extent that it keeps low-risk drivers in the pool. 
D)  prevents high-risk drivers from "selecting out," to the detriment of low-risk drivers. 
E)  increases the amount of information available to insurers about the population. 
A)  raises rates for everyone because it brings bad drivers into the pool. 
B)  raises rates for high-risk drivers. 
C)  may lower rates for all drivers to the extent that it keeps low-risk drivers in the pool. 
D)  prevents high-risk drivers from "selecting out," to the detriment of low-risk drivers. 
E)  increases the amount of information available to insurers about the population.

Which of the following would be LEAST likely to contribute to a moral hazard problem among drivers?

What is the problem with paying plant managers in multi-plant firms according to the level of output they produce?

The process by which sellers send signals to buyers conveying information about product quality is known as:

The principal-agent problem of ownership vs. control of the corporation arises when owners and managers

The problem of adverse selection in health insurance leads to a situation in which

The problem of production in multi-plant firms with asymmetric information can be solved by paying the manager

Suppose new electronic devices make it easier to monitor the effort levels of workers. If some shirking is still possible in the efficiency wage model, what happens to the efficiency wage?

Which incentive scheme would simultaneously elicit accurate information about feasible plant production levels and motivate managers to perform up to potential (in the following schemes, B is the bonus payment, Q is actual plant output, and Q_f is the manager's estimate of feasible output)?

If grades are to be a successful signal to potential employers of a student's qualities, then higher grades must be

When asymmetric information problems drive high quality products from a market, we refer to this situation as:

In the economic literature on principal-agent problems, the is the person who takes some action, and the is the person whom the action affects.

When states make car insurance mandatory for all drivers, it

Preliminaries

The Basics of Supply and Demand

Consumer Behavior

Individual and Market Demand

Uncertainty and Consumer Behavior

Production

The Cost of Production

Profit Maximization and Competitive Supply

The Analysis of Competitive Markets

Market Power: Monopoly and Monopsony

Pricing With Market Power

Monopolistic Competition and Oligopoly

Game Theory and Competitive Strategy

Markets for Factor Inputs

Investment, Time, and Capital Markets

General Equilibrium and Economic Efficiency

Externalities and Public Goods

Filters

Exam 17: Markets With Asymmetric Information

Which of the following would be LEAST likely to contribute to a moral hazard problem among drivers?

What is the problem with paying plant managers in multi-plant firms according to the level of output they produce?

The process by which sellers send signals to buyers conveying information about product quality is known as:

The principal-agent problem of ownership vs. control of the corporation arises when owners and managers

The problem of adverse selection in health insurance leads to a situation in which

The problem of production in multi-plant firms with asymmetric information can be solved by paying the manager

Suppose new electronic devices make it easier to monitor the effort levels of workers. If some shirking is still possible in the efficiency wage model, what happens to the efficiency wage?

Which incentive scheme would simultaneously elicit accurate information about feasible plant production levels and motivate managers to perform up to potential (in the following schemes, B is the bonus payment, Q is actual plant output, and Qf is the manager's estimate of feasible output)?

If grades are to be a successful signal to potential employers of a student's qualities, then higher grades must be

When asymmetric information problems drive high quality products from a market, we refer to this situation as:

In the economic literature on principal-agent problems, the ________ is the person who takes some action, and the ________ is the person whom the action affects.

When states make car insurance mandatory for all drivers, it

Preliminaries

The Basics of Supply and Demand

Consumer Behavior

Individual and Market Demand

Uncertainty and Consumer Behavior

Production

The Cost of Production

Profit Maximization and Competitive Supply

The Analysis of Competitive Markets

Market Power: Monopoly and Monopsony

Pricing With Market Power

Monopolistic Competition and Oligopoly

Game Theory and Competitive Strategy

Markets for Factor Inputs

Investment, Time, and Capital Markets

General Equilibrium and Economic Efficiency

Externalities and Public Goods

Filters

Which incentive scheme would simultaneously elicit accurate information about feasible plant production levels and motivate managers to perform up to potential (in the following schemes, B is the bonus payment, Q is actual plant output, and Q_f is the manager's estimate of feasible output)?

In the economic literature on principal-agent problems, the is the person who takes some action, and the is the person whom the action affects.