Exam 16: Asymmetric Information

The supply of used high-quality motorcycles is Q_H = 0.2P_H - 1,000, and the supply of used low-quality motorcycles is Q_L = 0.5P_L - 1,000. In the used-motorcycle market, potential buyers cannot tell them apart. Consumers value high-quality motorcycles at $10,000 and low-quality motorcycles at $6,000. If consumers believe there is a 50% probability that a used motorcycle is high quality, ____ low-quality motorcycles will be offered for sale at the consumers' willingness to pay.

Many people buy used smartphones from eBay, Craigslist, and so on. Some of these phones are good quality, but many others are not, and customers often have a difficult time distinguishing between the two types. Good smartphones are valued at $400 and poor ones at $100. The supply of good smartphones is given by Q_H = 2P_H - 300; that of poor smartphones is given by Q_L = 4P_L - 100. If consumers believe that 40% of used smartphones are good quality, then the expected price of a used smartphone is _____. At that price, _____ good smartphones and _____ poor ones will be sold, making the actual likelihood of buying a good phone equal to _____.

Suppose that, at an auction, there are four lawn mowers-two with a quality rating of 4 and two with a quality rating of 1. The scale runs from 1 to 4, with 1 being worst and 4 being near-mint condition. Sellers know the quality rating of their lawn mower and value it at 100Q, where Q is the quality rating. Buyers do not know the quality rating of any specific lawn mower, but assume here that buyers know the average quality rating of all the lawn mowers being offered for sale. Buyers value lawn mowers at , where Is the average quality rating of lawn mowers being offered for sale at the current auction price. Which of the following statements is (are) TRUE? I. At an auction price of $500 each, all four sellers are willing to sell their lawn mowers but will be unsuccessful. II. At an auction price of $300 each, two sellers are willing to sell their 1-quality-rated lawn mowers, but buyers are only willing to pay $150. III. At an auction price of $120 each, two 1-quality-rated lawn mowers will be sold.

In the used car market, what institutions help limit the lemons problem?

Adverse selection can occur when the: I. buyer has more information than the seller. II. seller has more information than the buyer. III. buyer and seller have complete information.

The market for used sea kayaks has both a high-quality and low-quality variety. High-quality kayaks are valued at $3,000 and low-quality ones at $800. Supply of used high-quality kayaks is Q_H = 0.5P_H - 1,000, and the supply of used low-quality kayaks is Q_L = P_L - 500. Potential buyers cannot distinguish between a high-quality and a low-quality used kayak. Buyers believe that only 3 of every 10 used kayaks are of high quality. In this market, buyers are willing to pay $____ for used kayaks.

Principal-agent problems arise from:

(Figure: Work Productivity) The figure shows the cost of college for high- and low-productivity workers. Based on the college wage premium:

(Table: Insurance Claims) Five people vary in health status. Each person knows his or her own health status and expected medical bills, which are given in the table. These people are considering buying health insurance. Assume that each person is equally likely to file a claim. Suppose that the insurance company does not know the health status of any one person but does know the expected claims of the group as a whole. If the insurance company sets the premium based on the average expected claims of these five people, then ____ people would be willing to pay the premium.

A stand-up paddleboard outfitter operates without insurance. The outfitter's marginal cost of safety (e.g., staff training, rescue equipment) is MC_A = 100 + 14A, where A is the number of safety actions taken. The marginal benefit of those actions is given by MB_B = 200 - 6A. The government has mandated that all SUP outfitters carry insurance, leading to a change in the outfitter's marginal benefit curve to MB_B = 140 - 6A. The optimal number of precautions taken by the outfitter is ____.

Identify whether any of the following situations is a moral hazard, adverse selection, or principal-agent problem. Explain your reasoning in each case. a. A person in poor health purchases life insurance. b. A consumer is taxed on the purchase of a carton of cigarettes. c. A driver purchases auto insurance and then drives more recklessly. d. A computer programmer works from home on a fixed salary.

Consumers value high-quality dirt bikes at $6,000 and low-quality dirt bikes at $2,500. The supply of used high-quality dirt bikes is Q_H = 0.5P_H - 2,000; the supply of used low-quality dirt bikes is Q_L = P_L - 1,000. Potential buyers cannot distinguish between the two. If buyers believe that half the used dirt bikes are high quality, what price are buyers willing to pay for a used dirt bike?

Suppose that the costs of going to college are given by: Low-ability person: C = $60,000y High-ability person: C = $30,000y where y is years in college. There are two types of workers, those with high ability and those with low ability. Employers cannot distinguish between them, so they pay each worker $250,000, the average value of output per worker. Employers will pay workers $380,000 if they earn a four-year degree. a. Will high-ability workers choose to get a four-year degree? What about low-ability workers? b. Because of rampant grade inflation, the cost of going to college for a low-ability person falls to C = 32,000y. Will low-ability workers choose to get a four-year degree? Does going to college serve as an effective signal?

At a swap meet, 10 sellers each have a used 5.7-L Chevy engine for sale. Half the engines are in mint condition, with each valued by its seller at $3,000. The other engines need repair, and each is valued by its seller at $1,000. Buyers value a mint engine at $3,500 and an engine that needs repair at $1,600. Sellers know whether their engine is in mint condition or needs repair, and buyers can distinguish between engines in mint condition and those needing repair. How many engines will be sold at the swap meet?

The cost of obtaining a four-year degree is $120,000 for low-ability workers and $60,000 for high-ability workers. Suppose that workers without a four-year degree are paid lifetime wages of $500,000. For education to be an effective signal of ability, what range of lifetime earnings must be paid to workers with a four-year degree?

Suppose there are two types of fruit pickers. Fast pickers bring in more than 10 units of fruit per day, while the slow pickers bring in fewer than 10 units per day. Johnson Farm pays pickers a flat rate of $50 per day, and Henry Farm pays pickers $5 for every unit picked. The pickers know their productivity level, but the farms don't know a picker's productivity until he or she starts working. Slow pickers will choose to apply at _____.

(Table: Car Quality Rating) At a sale of used cars, nine people are trying to sell their cars. Each of the sellers knows the quality rating of his car, all of which the table displays, and which range from 0 to 2. Sellers value their car at 1,000Q, where Q is its quality rating. Buyers do not know the value of any given car, but they do know the average quality rating of all cars that are available at the going price. Buyers value any given car at , where Is the average quality rating of the cars available for sale. At an auction price of $2,000, there will be ____ cars for sale.

(Table 16.3) You are the owner of a bowling alley, and you need to hire a manager to operate the facility. Because you live far from the bowling alley, you will not be able to keep an eye on the manager's effort. Your profit depends on the state of the economy and the manager's effort. A manager's utility depends on his salary and effort level, summarized as follows. Utility with low effort: U = salary Utility with high effort: U = salary - 8,000 a. If the owner pays the manager $50,000, how much effort will the manager put forth? What is the owner's expected profit net of the manager's salary? b. If the owner pays the manager $30,000 plus 10% of gross profits, how much utility will the manager receive, providing low effort and high effort? How much effort will the manager put forth? c. Is the owner better off paying the manager $50,000 or $30,000 plus 10% of gross profit?

Consider Troy and Paula, each of whom recently purchased health insurance with a 20% coinsurance rate (i.e., an insured person pays 20% of the price of a physician visit). Troy's demand curve for physician visits is Q_R = 6, and Paula's demand curve for physician visits is Q_P = 20 - 0.10P, where Q represents the number of physician visits and P is the price per visit. Suppose that the market price, P, for physician visits is $100. a. Without insurance coverage, how many physician visits do Troy and Paula make? b. Assuming a 20% coinsurance rate and market price of $100, what out-of-pocket price does Paula pay per visit with insurance coverage? c. With insurance coverage, how many times does Troy visit the physician? Paula? d. Explain whether Troy and Paula's purchase of health insurance created moral hazard.

Lenny, who has no mechanical knowledge of automobiles, takes his car to a mechanic because of a pinging noise in the engine. The transaction between Lenny and the mechanic is characterized by: