Question 1

Explain the concept of adverse selection. Give an example.

Accepted Answer

Adverse selection is a tendency for peop

Question 2

How can a warranty at the seller's expense signal that a product is high quality?

Accepted Answer

If the product is low quality, the warra

Question 3

-Marylou, whose utility of wealth curve is shown in the figure above, faces two options. Option A yields $200 for sure. Option B has a 0.3 probability of yielding $100, and a 0.7 probability of yielding $300. Marylou, who is

Accepted Answer

A)  picks option A. 
B)  picks option B. 
C)  is indifferent between option A and option B. 
D)  needs more information to make a choice. 
A)  picks option A. 
B)  picks option B. 
C)  is indifferent between option A and option B. 
D)  needs more information to make a choice.

Question 4

-John's utility of wealth curve is shown in the above figure. He currently has wealth of $20,000, and there is a 25 percent chance that he could lose it all. If an insurance company offers to insure against this loss for $6,000, John will

Accepted Answer

A)  buy the policy. 
B)  not buy the policy. 
C)  be indifferent between being insured and uninsured. 
D)  There is not enough information to answer. 
A)  buy the policy. 
B)  not buy the policy. 
C)  be indifferent between being insured and uninsured. 
D)  There is not enough information to answer.

Question 5

-Jimmy's utility of wealth schedule is given in the table above. Jimmy has a job with a one-third chance of earning $200 and a two-thirds chance of earnings $400. Jimmy's cost of risk is

Accepted Answer

A)  $0. 
B)  $16.67. 
C)  $33.33. 
D)  Jimmy's cost of risk cannot be determined without more information. 
A)  $0. 
B)  $16.67. 
C)  $33.33. 
D)  Jimmy's cost of risk cannot be determined without more information.

Question 6

-Andrew has the utility of wealth curve shown in the above figure. He owns an SUV worth $30,000, and that is his only wealth. There is a 10 percent chance that he will have an accident within a year. If he does have an accident, his SUV is worthless. Andrew would have the same expected utility as he currently has if his wealth was ________ and he faced no uncertainty.

Accepted Answer

A)  $30,000 
B)  $27,000 
C)  $21,000 
D)  $18,000 
A)  $30,000 
B)  $27,000 
C)  $21,000 
D)  $18,000

Question 7

-Andrew has the utility of wealth curve shown in the above figure. He owns an SUV worth $30,000, and that is his only wealth. There is a 10 percent chance that he will have an accident within a year. If he does have an accident, his SUV is worthless. The value of insurance to Andrew against an accident is

Accepted Answer

A)  zero. 
B)  $3,000 per year. 
C)  $10,000 per year. 
D)  $6,000 per year. 
A)  zero. 
B)  $3,000 per year. 
C)  $10,000 per year. 
D)  $6,000 per year.

Question 8

-Bobby is offered two fulltime jobs. In the first job, as a salesperson, he has a 50 percent chance to make $2,000 a month and a 50 percent chance to make $10,000 a month. The second job, as a construction worker, pays $4,500 a month with certainty. Bobby's utility of wealth curve is shown in the figure above. Bobby will take the ________ job because his expected ________ from this job is greater.

Accepted Answer

A)  first; utility 
B)  second; utility 
C)  second; income 
D)  first; income 
A)  first; utility 
B)  second; utility 
C)  second; income 
D)  first; income

Question 9

Expected wealth is a weighted average in which the weights are

Accepted Answer

A)  average utilities. 
B)  marginal utilities. 
C)  total utilities. 
D)  probabilities. 
A)  average utilities. 
B)  marginal utilities. 
C)  total utilities. 
D)  probabilities.

Question 10

-Steve owns a motorcycle valued at $5,000, and that is his only asset. There is a 5 percent chance that Steve will have an accident within a year. If he does have an accident, his motorcycle is worthless. Steve's utility of wealth curve is shown in the figure above. An insurance company agrees to pay Steve the full value of his motorcycle in case of an accident if he buys the company's insurance policy. The company's operating expenses are $500 per policy. With no insurance, Steve's expected wealth is

Accepted Answer

A)  $4,000. 
B)  $4,500. 
C)  $3,500. 
D)  $5,000. 
A)  $4,000. 
B)  $4,500. 
C)  $3,500. 
D)  $5,000.

Question 11

Diminishing marginal utility of wealth leads to risk aversion because at a given level of wealth a dollar gained

Accepted Answer

A)  is worth more in additional utility than a dollar lost. 
B)  is worth less in additional utility than a dollar lost. 
C)  is worth as much in additional utility as a dollar lost. 
D)  does not add to total utility. 
A)  is worth more in additional utility than a dollar lost. 
B)  is worth less in additional utility than a dollar lost. 
C)  is worth as much in additional utility as a dollar lost. 
D)  does not add to total utility.

Question 12

-Based on the table and information in the previous question, which of the following is true?

Accepted Answer

A)  George prefers to make $15,000 with certainty than make the investment. 
B)  George prefers making the investment than to make $15,000 with certainty. 
C)  George is indifferent between making $15,000 with certainty and making the investment. 
D)  As the investment has risk George should not make it under any circumstances. 
A)  George prefers to make $15,000 with certainty than make the investment. 
B)  George prefers making the investment than to make $15,000 with certainty. 
C)  George is indifferent between making $15,000 with certainty and making the investment. 
D)  As the investment has risk George should not make it under any circumstances.

Question 13

An increase in Meta's wealth from $3,000 to $6,000 raises her utility from 80 units to 100 units. If she is risk averse, with a wealth of $9,000 her utility might be

Accepted Answer

A)  99 units. 
B)  114 units. 
C)  120 units. 
D)  126 units. 
A)  99 units. 
B)  114 units. 
C)  120 units. 
D)  126 units.

Question 14

Suppose that there are only two types of used cars, peaches and lemons. Peaches are worth $10,000 and lemons are worth $4,000. Without effective signals such as warranties, the owners of peaches cannot sell their cars for $10,000 because the

Accepted Answer

A)  owners of peaches cannot convince buyers that their cars are worth $10,000. 
B)  buyers cannot convince owners of peaches to sell their cars for $10,000. 
C)  owners of lemons cannot convince buyers that their cars are worth more than $4,000. 
D)  buyers cannot convince owners of lemons to sell their cars for $4,000. 
A)  owners of peaches cannot convince buyers that their cars are worth $10,000. 
B)  buyers cannot convince owners of peaches to sell their cars for $10,000. 
C)  owners of lemons cannot convince buyers that their cars are worth more than $4,000. 
D)  buyers cannot convince owners of lemons to sell their cars for $4,000.

Question 15

Moral hazard and adverse selection are the result of

Accepted Answer

A)  poorly functioning markets. 
B)  government intervention. 
C)  private information. 
D)  treachery. 
A)  poorly functioning markets. 
B)  government intervention. 
C)  private information. 
D)  treachery.

Question 16

Moral hazard is

Accepted Answer

A)  the tendency for people to enter into agreements in which they can use their private information to their own advantage and to the disadvantage of the less informed party. 
B)  when one of the parties to an agreement has an incentive after the agreement is made to act in a manner that brings additional benefits to himself or herself at the expense of the other party. 
C)  a situation in which only bad quality items are bought and sold. 
D)  an action taken outside a market that conveys information that can be used by that market. 
A)  the tendency for people to enter into agreements in which they can use their private information to their own advantage and to the disadvantage of the less informed party. 
B)  when one of the parties to an agreement has an incentive after the agreement is made to act in a manner that brings additional benefits to himself or herself at the expense of the other party. 
C)  a situation in which only bad quality items are bought and sold. 
D)  an action taken outside a market that conveys information that can be used by that market.

Question 17

The cost of risk is the amount by which expected wealth must increase to give the same ________ as a no-risk situation.

Accepted Answer

A)  marginal wealth 
B)  marginal utility 
C)  expected utility 
D)  expected wealth 
A)  marginal wealth 
B)  marginal utility 
C)  expected utility 
D)  expected wealth

Question 18

If a lender checks credit reports on individuals before mailing out loan offers, it is most likely trying to avoid

Accepted Answer

A)  moral hazard. 
B)  moral dilemma. 
C)  adverse selection. 
D)  adverse reaction. 
A)  moral hazard. 
B)  moral dilemma. 
C)  adverse selection. 
D)  adverse reaction.

Question 19

If reckless drivers are more likely than safe drivers to buy automobile insurance, then a moral hazard problem has occurred.

Accepted Answer

A) True 
 B)False

Question 20

Which of the following is an example of moral hazard?

Accepted Answer

A)  I hire you to work in my garden for a fixed fee, and you work hard all day. 
B)  I hire you to work at an hourly rate and you work as slowly as possible. 
C)  You apply for the job only because I pay a fixed wage per day, no matter how much or little you do. 
D)  You agree to be paid by the weed to work in my garden, and then don't work hard. 
A)  I hire you to work in my garden for a fixed fee, and you work hard all day. 
B)  I hire you to work at an hourly rate and you work as slowly as possible. 
C)  You apply for the job only because I pay a fixed wage per day, no matter how much or little you do. 
D)  You agree to be paid by the weed to work in my garden, and then don't work hard.

Exam 20: Uncertainty and Information

Explain the concept of adverse selection. Give an example.

How can a warranty at the seller's expense signal that a product is high quality?

-Marylou, whose utility of wealth curve is shown in the figure above, faces two options. Option A yields $200 for sure. Option B has a 0.3 probability of yielding $100, and a 0.7 probability of yielding $300. Marylou, who is

-John's utility of wealth curve is shown in the above figure. He currently has wealth of $20,000, and there is a 25 percent chance that he could lose it all. If an insurance company offers to insure against this loss for $6,000, John will

-Jimmy's utility of wealth schedule is given in the table above. Jimmy has a job with a one-third chance of earning $200 and a two-thirds chance of earnings $400. Jimmy's cost of risk is

Expected wealth is a weighted average in which the weights are

Diminishing marginal utility of wealth leads to risk aversion because at a given level of wealth a dollar gained

-Based on the table and information in the previous question, which of the following is true?

An increase in Meta's wealth from $3,000 to $6,000 raises her utility from 80 units to 100 units. If she is risk averse, with a wealth of $9,000 her utility might be

Suppose that there are only two types of used cars, peaches and lemons. Peaches are worth $10,000 and lemons are worth $4,000. Without effective signals such as warranties, the owners of peaches cannot sell their cars for $10,000 because the

Moral hazard and adverse selection are the result of

Moral hazard is

The cost of risk is the amount by which expected wealth must increase to give the same ________ as a no-risk situation.

If a lender checks credit reports on individuals before mailing out loan offers, it is most likely trying to avoid

If reckless drivers are more likely than safe drivers to buy automobile insurance, then a moral hazard problem has occurred.

Which of the following is an example of moral hazard?

What Is Economics

The Economic Problem

Demand and Supply

Elasticity

Efficiency and Equity

Government Actions in Markets

Global Markets in Action

Utility and Demand

Possibilities, Preferences, and Choices

Organizing Production

Output and Costs

Perfect Competition

Monopoly

Monopolistic Competition

Oligopoly

Public Choices and Public Goods

Externalities and the Environment

Markets for Factors of Production

Economic Inequality

Extension A: Review

Extension B: Review

Extension C: Review

Extension D: Review

Extension E: Review

Extension F: Review

Filters