Exam 17: Uncertainty and Asymmetric Information

Annie, a high school student, babysits to earn extra cash. In order to differentiate herself from other babysitters, Annie took a babysitting course from the Red Cross. This is an example of a market signal.

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. Over time the price in the market for 2006 Accords will ________ and ________ will be traded.

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. From the table, we can see that Sue is

Refer to the Economics in Practice on page 358. Advertisements provide information in two ways-what they say and what they omit.

Incentives can be used to reduce both adverse selection and moral hazard.

A lender faces a(n) ________ problem if borrowers with a greater chance of defaulting on their loans get loans from the lender.

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. Dmitri's expected value from the first job offer is ________ and is ________ from the second job offer.

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

Refer to the data provided in Table 17.1 below to answer the following question(s). The table shows the relationship between income and utility for Jane. Table 17.1 -Refer to Table 17.1. Suppose Jane has a 1/3 chance of becoming disabled in any given year. If she does become disabled, she will earn $0. If Jane does not become disabled, she will earn her usual salary of $60,000. Jane has the opportunity to purchase disability insurance which will pay her her full salary in the event she becomes disabled. On average, how much would such a contract cost the insurance company (per person)?

Relating to the Economics in Practice on page 356: An individual with a parent who has Huntington's disease has a 50 percent chance of also having the disease, and can use this information when deciding on the purchase of health insurance. This is an example of ________ favoring potential insurance buyers.

Refer to the data provided in Table 17.4 below to answer the following question(s). The table shows the relationship between income and utility for Celeste. Table 17.4 -Refer to Table 17.4. Suppose Celeste has a 1/3 chance of becoming disabled in any given year. If she does become disabled, she will earn $0. If Celeste does not become disabled, she will earn her usual salary of $120,000. Celeste has the opportunity to purchase disability insurance for $40,000 which will pay her her full salary in the event she becomes disabled. Celeste's utility with the policy is

You own a car dealership and pay all of your sales people a flat salary. As a result, they don't work very hard to generate sales. This is an example of

The sum of the utilities from each possible outcome of a situation weighted by the probability of that outcome is known as

Refer to the data provided in Table 17.4 below to answer the following question(s). The table shows the relationship between income and utility for Celeste. Table 17.4 -Refer to Table 17.4. Suppose Celeste has a 1/3 chance of becoming disabled in any given year. If she does become disabled, she will earn $0. If Celeste does not become disabled, she will earn her usual salary of $120,000. Celeste has the opportunity to purchase disability insurance which will pay her her full salary in the event she becomes disabled. Such an insurance policy would be worth ________ to Celeste.

Performance compensation that is tied to outcomes out of the employees' control will provide employees with the incentive to work hard.

Moral hazard occurs when one party to a contract changes his behavior in response to that contract and thus passes on costs of that behavior to the other party.

Warranties, education, extracurricular activities are all examples of

In general, risk-loving individuals experience increasing marginal utility from income.

Adverse selection and moral hazard arise because of

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. We would say that Sam is risk neutral based on his