Question 1

The insurance industry is susceptible to moral hazard problems, but not problems of adverse selection.

Accepted Answer

A) True 
 B)False  False

Question 2

Refer to the data provided in Table 17.2 below to answer the following question(s). The table shows the relationship between income and utility for Sue.
Table 17.2
  
-Refer to Table 17.2. Sue earns $40,000 annually. She has the opportunity to bet her entire salary on the upcoming super bowl. If Sue takes the bet, she will pick the Patriots. She believes that the Patriots have a 50-50 chance of winning the game. If the Patriots win, Sue will double her money ($80,000) but if they lose she loses her entire salary ($0). Sue's utility if she does not take the bet is ________ and her expected utility from the bet is ________.

Accepted Answer

A)  40; 80 
B)  40; 40 
C)  40; 0 
D)  80; 20 
A)  40; 80 
B)  40; 40 
C)  40; 0 
D)  80; 20 B

Question 3

You cause an automobile liability insurance company to face a moral hazard problem when you take ________ driving precautions ________ you buy automobile liability insurance from the company.

Accepted Answer

A)  fewer; after 
B)  more; after 
C)  fewer; before 
D)  the same; before and after 
A)  fewer; after 
B)  more; after 
C)  fewer; before 
D)  the same; before and after A

Question 4

Refer to the data provided in Table 17.3 below to answer the following question(s). The table shows the relationship between income and utility for Terri.
Table 17.3
  
-Refer to Table 17.3. Suppose Terri has a 25% chance of becoming disabled in any given year. If she does become disabled, she will earn $0. If Terri does not become disabled, she will earn her usual salary of $80,000. Terri has the opportunity to purchase disability insurance for $20,000 which will pay her her full salary in the event she becomes disabled. Terri's utility with the policy is ________ and her expected utility without the policy is ________.

Accepted Answer

A)  56.25; 45 
B)  45; 56.25 
C)  45; 18.75 
D)  18.75; 37.5 
A)  56.25; 45 
B)  45; 56.25 
C)  45; 18.75 
D)  18.75; 37.5

Question 5

In the market for used electric wheelchairs, there are high- and low-quality wheelchairs. Potential buyers cannot determine prior to purchase whether a wheelchair is high or low quality. The following statement that best describes what is likely to happen in this market is

Accepted Answer

A)  this is an example of adverse selection, as the buyer will have more information about the quality of the used wheelchair than will the seller. 
B)  over time the market price of a used wheelchair will increase, as there is more of an incentive for owners of high-quality wheelchairs to sell than owners of low-quality wheelchairs. 
C)  the price of a used wheelchair will be very close to the value of a high-quality wheelchair, which will encourage people to sell high-quality wheelchairs. 
D)  the price of a used wheelchair will be between the buyer and seller values for low-quality wheelchairs. This will encourage people to withdraw high-quality wheelchairs from the market. 
A)  this is an example of adverse selection, as the buyer will have more information about the quality of the used wheelchair than will the seller. 
B)  over time the market price of a used wheelchair will increase, as there is more of an incentive for owners of high-quality wheelchairs to sell than owners of low-quality wheelchairs. 
C)  the price of a used wheelchair will be very close to the value of a high-quality wheelchair, which will encourage people to sell high-quality wheelchairs. 
D)  the price of a used wheelchair will be between the buyer and seller values for low-quality wheelchairs. This will encourage people to withdraw high-quality wheelchairs from the market.

Question 6

Refer to the data provided in Table 17.5 below to answer the following question(s). The table shows the relationship between income and utility for Lucy.
Table 17.5
  
-Refer to Table 17.5. Lucy earns $20,000 annually. She has the opportunity to bet her entire salary on the upcoming super bowl. If Lucy takes the bet, she will pick the Packers. She believes that the Packers have a 50-50 chance of winning the game. If the Packers win, Lucy will double her money ($40,000) but if they lose she loses her entire salary ($0). Lucy's utility if she does not take the bet is

Accepted Answer

A)  20 and her expected utility from the bet is 40. 
B)  20 and her expected utility from the bet is 20. 
C)  20 and her expected utility from the bet is 0. 
D)  40 and her expected utility from the bet is 10. 
A)  20 and her expected utility from the bet is 40. 
B)  20 and her expected utility from the bet is 20. 
C)  20 and her expected utility from the bet is 0. 
D)  40 and her expected utility from the bet is 10.

Question 7

Refer to the information provided in Figure 17.1 below to answer the question(s) that follow.   Figure 17.1
-Refer to Figure 17.1. Dmitri has two job offers when he graduates from college. Dmitri views the offers as identical, except for the salary terms. The first offer is at a fixed annual salary of $40,000. The second offer is at a fixed salary of $20,000 plus a possible bonus of $40,000. Dmitri believes that he has a 50-50 chance of earning the bonus. If Dmitri takes the offer that maximizes his expected utility and is he is risk averse, then

Accepted Answer

A)  he will take the first offer. 
B)  he will take the second offer. 
C)  he is indifferent between the offers-both yield the same expected utility. 
D)  Indeterminate from the given information-we cannot say what he will do. 
A)  he will take the first offer. 
B)  he will take the second offer. 
C)  he is indifferent between the offers-both yield the same expected utility. 
D)  Indeterminate from the given information-we cannot say what he will do.

Question 8

You are in the market for a used 2013 Toyota Corolla. You know that half of the 2013 Corollas are lemons and half are peaches. If you could be assured that the Corolla you were buying was a peach, you would be willing to pay up to $12,000. On the other hand, you would only be willing to pay $4,000 for a lemon. You have no ability to discern whether any particular Corolla is a lemon or a peach. Sellers of Corollas, on the other hand, are likely to know whether their particular car is a lemon or a peach. Suppose sellers of lemons will sell their cars for $3,000 or more and peach sellers will be willing to sell their cars for $9,000 or more. If you are risk neutral, you are willing to offer ________ and ________ are willing to sell you their car.

Accepted Answer

A)  $4,000 for a car of unknown quality; lemon owners only 
B)  $6,000 for a car of unknown quality; lemon owners only 
C)  $8,000 for a car of unknown quality; lemon owners only 
D)  $9,000 for a car of unknown quality; both lemon and peach owners 
A)  $4,000 for a car of unknown quality; lemon owners only 
B)  $6,000 for a car of unknown quality; lemon owners only 
C)  $8,000 for a car of unknown quality; lemon owners only 
D)  $9,000 for a car of unknown quality; both lemon and peach owners

Question 9

Refer to the data provided in Table 17.2 below to answer the following question(s). The table shows the relationship between income and utility for Sue.
Table 17.2
  
-Refer to Table 17.2. Sue earns $40,000 annually. She has the opportunity to bet her entire salary on the upcoming super bowl. If Sue takes the bet, she will pick the Patriots. She believes that the Patriots have a 50-50 chance of winning the game. If the Patriots win, Sue will win $81,000 but if they lose she loses her entire salary ($0). Will Sue take the bet?

Accepted Answer

A)  yes 
B)  no 
C)  maybe 
D)  indeterminate from the given information 
A)  yes 
B)  no 
C)  maybe 
D)  indeterminate from the given information

Question 10

A diagram of an individual's utility from income will be a line with a constant slope if the individual is risk-neutral.

Accepted Answer

A) True 
 B)False

Question 11

Refer to the information provided in Figure 17.1 below to answer the question(s) that follow.   Figure 17.1
-Refer to Figure 17.1. John has two job offers when he graduates from college. John views the offers as identical, except for the salary terms. The first offer is at a fixed annual salary of $50,000. The second offer is at a fixed salary of $20,000 plus a possible bonus of $60,000. John believes that he has a 50-50 chance of earning the bonus. If John takes the offer that maximizes his expected utility and is risk-averse, which job offer will he choose?

Accepted Answer

A)  John will take the first offer. 
B)  John will take the second offer. 
C)  John is indifferent between the offers-both yield the same expected utility. 
D)  Indeterminate from the given information. 
A)  John will take the first offer. 
B)  John will take the second offer. 
C)  John is indifferent between the offers-both yield the same expected utility. 
D)  Indeterminate from the given information.

Question 12

Mark has two job offers when he graduates from college. Mark views the offers as identical, except for the salary terms. The first offer is at a fixed annual salary of $50,000. The second offer is at a fixed salary of $20,000 plus a possible bonus of $60,000. Mark believes that he has a 50-50 chance of earning the bonus. If Mark takes the offer that maximizes his expected utility and is risk-neutral, which job offer will he choose?

Accepted Answer

A)  Mark will take the first offer. 
B)  Mark will take the second offer. 
C)  Mark is indifferent between the offers-both yield the same expected utility. 
D)  Indeterminate from the given information. 
A)  Mark will take the first offer. 
B)  Mark will take the second offer. 
C)  Mark is indifferent between the offers-both yield the same expected utility. 
D)  Indeterminate from the given information.

Question 13

Consider the following game. You roll a six-sided die and each time you roll a 6, you get $30. For all other outcomes you pay $6. The $30 when you "win" and the -$6 when you "lose" are called

Accepted Answer

A)  payoffs. 
B)  trade-offs. 
C)  incentives. 
D)  expected values. 
A)  payoffs. 
B)  trade-offs. 
C)  incentives. 
D)  expected values.

Question 14

In the labor market, contracts are often designed to include a variable salary component that is tied to some measure of performance. Why?

Accepted Answer

A)  Such contracts provide workers with the incentive to work hard. 
B)  Most people are risk-loving and thus variability in their compensation leads to higher total utility. 
C)  Labor unions demand a variable salary component. 
D)  The variable component reduces wages paid by firms. 
A)  Such contracts provide workers with the incentive to work hard. 
B)  Most people are risk-loving and thus variability in their compensation leads to higher total utility. 
C)  Labor unions demand a variable salary component. 
D)  The variable component reduces wages paid by firms.

Question 15

You are in the market for a used 2006 Honda Accord. You know that half of the 2006 Accords are lemons and half are peaches. If you could be assured that the Accord you were buying was a peach, you would be willing to pay up to $10,000. On the other hand, you would only be willing to pay $2,000 for a lemon. You have no ability to discern whether any particular Accord is a lemon or a peach. Sellers of Accords, on the other hand, are likely to know whether their particular car is a lemon or a peach. Suppose sellers of lemons will sell their cars for $1,500 or more and peach sellers will be willing to sell their cars for $8,500 or more. You are willing to offer ________ for a car of unknown quality and ________ are willing to sell you their car.

Accepted Answer

A)  $2,000; lemon owners only 
B)  $5,000; lemon owners only 
C)  $6,000; lemon owners only 
D)  $8,500; both lemon and peach owners 
A)  $2,000; lemon owners only 
B)  $5,000; lemon owners only 
C)  $6,000; lemon owners only 
D)  $8,500; both lemon and peach owners

Question 16

Refer to the information provided in Figure 17.2 below to answer the question(s) that follow.   Figure 17.2
-Refer to Figure 17.2. Fiona has two job offers when she graduates from college. Fiona views the offers as identical, except for the salary terms. The first offer is at a fixed annual salary of $60,000. The second offer is at a fixed salary of $20,000 plus a possible bonus of $80,000. Fiona believes that she has a 50-50 chance of earning the bonus. If Fiona takes the offer that maximizes her expected utility and she is risk-neutral, then

Accepted Answer

A)  she will take the first offer. 
B)  she will take the second offer. 
C)  she is indifferent between the offers-both yield the same expected utility. 
D)  Indeterminate from the given information-we cannot say what she will do. 
A)  she will take the first offer. 
B)  she will take the second offer. 
C)  she is indifferent between the offers-both yield the same expected utility. 
D)  Indeterminate from the given information-we cannot say what she will do.

Question 17

All of the following statements about asymmetric information are true except

Accepted Answer

A)  asymmetric information occurs when one party to a transaction has relevant information to the transaction that the other party does not have. 
B)  asymmetric information creates market failures because it makes it harder for individuals to engage in transactions that would take place in the presence of perfect information. 
C)  asymmetric information can only be solved through government intervention. 
D)  asymmetric information occurs in the market for used cars and in the insurance market. 
A)  asymmetric information occurs when one party to a transaction has relevant information to the transaction that the other party does not have. 
B)  asymmetric information creates market failures because it makes it harder for individuals to engage in transactions that would take place in the presence of perfect information. 
C)  asymmetric information can only be solved through government intervention. 
D)  asymmetric information occurs in the market for used cars and in the insurance market.

Question 18

Market signals are

Accepted Answer

A)  actions taken by buyers and sellers to communicate quality in the presence of perfect information. 
B)  only strong if obtaining the signal is more costly for individuals with valued traits than for those with non-valued traits. 
C)  used to differentiate those who will drive equally carefully whether or not they have auto insurance from those who drive less carefully when they have insurance. 
D)  used to distinguish between high and low quality and help correct the adverse selection problem. 
A)  actions taken by buyers and sellers to communicate quality in the presence of perfect information. 
B)  only strong if obtaining the signal is more costly for individuals with valued traits than for those with non-valued traits. 
C)  used to differentiate those who will drive equally carefully whether or not they have auto insurance from those who drive less carefully when they have insurance. 
D)  used to distinguish between high and low quality and help correct the adverse selection problem.

Question 19

________ arises when one party to a contract changes behavior in response to that contract, passing the cost of that change in behavior to the other party.

Accepted Answer

A)  Adverse selection 
B)  Moral hazard 
C)  Logrolling 
D)  Market signaling 
A)  Adverse selection 
B)  Moral hazard 
C)  Logrolling 
D)  Market signaling

Question 20

Consider the following game. You pick a card from a 52-card deck and each time you select a queen, you get $520. For all other cards pay $26. The expected value of the game is

Accepted Answer

A)  -$24. 
B)  $0. 
C)  $16. 
D)  $64. 
A)  -$24. 
B)  $0. 
C)  $16. 
D)  $64.

Exam 17: Uncertainty and Asymmetric Information

The insurance industry is susceptible to moral hazard problems, but not problems of adverse selection.

You cause an automobile liability insurance company to face a moral hazard problem when you take ________ driving precautions ________ you buy automobile liability insurance from the company.

In the market for used electric wheelchairs, there are high- and low-quality wheelchairs. Potential buyers cannot determine prior to purchase whether a wheelchair is high or low quality. The following statement that best describes what is likely to happen in this market is

A diagram of an individual's utility from income will be a line with a constant slope if the individual is risk-neutral.

Consider the following game. You roll a six-sided die and each time you roll a 6, you get $30. For all other outcomes you pay $6. The $30 when you "win" and the -$6 when you "lose" are called

In the labor market, contracts are often designed to include a variable salary component that is tied to some measure of performance. Why?

All of the following statements about asymmetric information are true except

Market signals are

________ arises when one party to a contract changes behavior in response to that contract, passing the cost of that change in behavior to the other party.

Consider the following game. You pick a card from a 52-card deck and each time you select a queen, you get $520. For all other cards pay $26. The expected value of the game is

The Scope and Method of Economics

The Economic Problem: Scarcity and Choice

Demand, Supply, and Market Equilibrium

Demand and Supply Applications

Elasticity

Household Behavior and Consumer Choice

The Production Process: the Behavior of Profit-Maximizing Firms

Short-Run Costs and Output Decisions

Long-Run Costs and Output Decisions

Input Demand: The Labor and Land Markets

Input Demand: The Capital Market and the Investment Decision

General Equilibrium and the Efficiency of Perfect Competition

Monopoly and Antitrust Policy

Oligopoly

Monopolistic Competition

Externalities, Public Goods, and Common Resources

Income Distribution and Poverty

Public Finance: The Economics of Taxation

Introduction to Macroeconomics

Measuring National Output and National Income

Unemployment, Inflation, and Long-Run Growth

Aggregate Expenditure and Equilibrium Output

The Government and Fiscal Policy

Money, the Federal Reserve, and the Interest Rate

The Determination of Aggregate Output, the Price Level, and the Interest Rate

Policy Effects and Cost Shocks in the Asad Model

The Labor Market in the Macroeconomy

Financial Crises, Stabilization, and Deficits

Household and Firm Behavior in the Macroeconomy: a Further Look

Long-Run Growth

Alternative Views in Macroeconomics

International Trade, Comparative Advantage, and Protectionism

Open-Economy Macroeconomics: the Balance of Payments and Exchange Rates

Economic Growth in Developing Economies

Critical Thinking About Research

Filters

You cause an automobile liability insurance company to face a moral hazard problem when you take driving precautions you buy automobile liability insurance from the company.