Exam 16: Asymmetric Information

Suppose half of workers have high productivity and half of workers have low productivity. High-productivity workers are valued at $100,000 a year and low-productivity workers are valued at $40,000 a year. Because of asymmetric information, employers cannot tell them apart, so all workers are paid according to the average economy-wide value of productivity. If high-productivity workers found a method to signal their productivity to employers, high-productivity pay would _____ by $30,000, and low-productivity pay would _____.

Which of the following statements is (are) TRUE? I. The lemons problem causes an inefficiently high number of sales in high-quality goods. II. The lemons problem affects how much buyers are willing to pay for goods. III. The lemons problem does not affect the market for services.

Vehicle leasing _____ the number of high-quality used cars and _____ adverse selection.

Eric has a job at an electronics store in a mall. Eric doesn't like to work hard, and it costs him $100 to do so. Eric's employer cannot observe whether Eric works hard or not. If Eric works hard, there is a 75% probability that electronics goods profits will equal $400 a day and a 25% probability that electronics goods profits will equal $100 a day. If Eric shirks, there is a 75% probability that electronics goods profits will equal $100 a day and a 25% probability that electronics goods profits will equal $400 a day. Suppose Eric is paid $200 if electronics goods profits are $400 a day and $50 if electronics goods profits are $100 a day. Eric will _____ because the net gain of _____ from shirking is _____ than the net gain of _____ from working hard.

Your car needs an oil change. After working on the car, your mechanic comes out to the waiting room and tells you your car needs a tire alignment. Does this transaction exhibit asymmetric information? Explain.

Vivaan, a musician, frequently plays at large parties and nightclubs. Vivaan has musical equipment worth $8,000, and he takes precautions to prevent theft. The marginal benefit of these precautions is given by MB = 60 - 3A, where A is the number of precautions Vivaan takes. The marginal cost of preventing theft (i.e., the time, energy, and effort expended) is given by MC = 2A. Suppose Vivaan purchases full insurance that pays him $8,000 if his gear is stolen. What is Vivaan's optimal level of precautions?

Suppose a company's owners have a hard time observing whether management is acting primarily in its own interest or for the benefit of the company. This situation sets up a:

(Figure: Fire Insurance) Lilly, who owns the Cigar Bar and Grill, is considering whether to purchase fire insurance. Without insurance, the marginal benefit of precautions to reduce the risk of fire is given by MB₁.Which of the following statements is (are) TRUE? I. With full insurance, the marginal benefit of acting to reduce the risk of fire is given by MB₃. II) If Lilly purchases fire insurance, whether it is full or partial coverage, the marginal benefits of acting to reduce the risk of fire will increase. III) With partial insurance, the marginal benefit of acting to reduce the risk of fire is given by MB₂.

A small town has 1,000 people, 600 of whom are healthy and 400 of whom are sick. The annual expected medical claims of the healthy and sick are $500 and $9,000, respectively. If the insurance company cannot determine who is healthy and who is sick prior to the purchase of insurance, the annual premium must be at least $____.

(Figure: Principal-Agent Game I) What is the equilibrium in this principal-agent game?

Farmer Marley grows barley, and every year he risks losing his crop to drought, insects, or disease. Precautions such as proper soil preparation and the judicious use of water, fertilizer, and pesticide can reduce the risk of crop failure. The marginal benefit and marginal cost of these precautions are MB = 120 - 4A and MC = 20 + A, where A is the number of precautions. a. How many precautions does Marley take? b. Suppose that Marley buys insurance against the risk of crop failure, which changes the marginal benefit of precautions to MB = 100 - 7A. How many precautions does Marley now take?

The costs of obtaining a college degree for high-productivity and low-productivity workers are as follows: High productivity: C_H = $20,000y Low productivity: C_L = $40,000y Where y is years in college. Suppose workers with a college degree are paid a lifetime income of $600,000, and workers without a college degree are paid a lifetime income of $450,000. For low-productivity workers, the net benefit of four years of college is _____, while the net benefit of not going to college is _____.

Which of the following methods reduce adverse selection in insurance markets? I. selling insurance policies to groups of employees in a firm II. requiring medical exams for anyone purchasing life insurance III. denying insurance coverage to people with preexisting health conditions IV. mandating by law that all people must buy health insurance

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. With a 20% coinsurance rate and a market price of $100, Paula pays $____ out-of-pocket per visit.

(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, buyers value the cars for sale at $____ each.

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, ____ high-quality motorcycles will be offered for sale at the consumers' willingness to pay.

(Figure: Theft Prevention) If an individual with no insurance purchases partial coverage, the marginal _____ curve will shift _____, leading her to _____ theft prevention measures.

In the market for used air rifles, the overwhelming majority of rifles for sale do not shoot very accurately. This situation is an example of _____ and results from _____.

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, while the supply of used low-quality dirt bikes is Q_L = P_L - 1,000. Potential buyers cannot distinguish between the two. Buyers base their willingness to pay on the belief that half the used dirt bikes are high quality. At the buyers' willingness to pay, sellers will offer _____ high-quality bikes and _____ low-quality ones.

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. The marginal benefit of those actions is given by MB_B = 200 - 6A, where A is the number of safety actions taken. What is the optimal number of precautions for this outfitter to take?