Exam 16: Asymmetric Information

Ted purchased a comprehensive insurance policy for his car. Which of the following is an example of moral hazard?

Eric works 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. If Eric works hard, there is a 90% probability that electronics goods profits will equal $400 a day and a 10% probability that electronics goods profits will equal $100 a day. If Eric shirks, there is a 90% probability that electronics goods profits will equal $100 a day and a 10% 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.

Suppose that a company offers insurance for the cost of surgical hair replacement. After selling this insurance for a short period, the company finds that almost all of its customers are undergoing hair replacement treatment and filing a claim. What problem does the company face? Is there anything it could do to limit this problem?

Suppose that a publisher is considering how to pay an author for writing a book. The publisher would like the author to put forth his maximum effort, but the publisher is unable to observe the author's effort. In this example, the agent is ____.

In a small island population, half of the people are healthy and half are sick. The annual expected medical claims of the healthy and sick are $200 and $4,000, respectively. Assume that the health insurance company does not know whether people are healthy or sick before they buy insurance. If the health insurance company charges an annual premium of $2,100 (the average expected claim), only the _____ will buy insurance, driving future premiums _____.

Based on John List's research on sports memorabilia shows, buyers of antique furniture at a flea market should be advised to:

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. 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. Suppose Eric is paid $200 if electronics goods profits are $400 a day and $50 if electronics goods profits are $100 a day. What is Eric's expected pay for working hard?

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. a. 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, what price are consumers willing to pay for any used motorcycle? b. At the price determined in part a, how many high-quality and low-quality motorcycles will be offered for sale? What will happen over time to the consumers' willingness to pay for used motorcycles?

A small town has 1,000 people, of whom 400 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, what annual premium will they set? Will this lead to adverse selection? Why or why not?

(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 the premium is ____.

Answer the following questions. a. Some health analysts believe that physicians try to increase their income by inducing demand for their services. For example, physicians may order unnecessary tests and treatments. Why would patients willingly accept these additional tests and treatments? b. If physicians did not need a license to practice medicine, what market institutions would help mitigate the lemons problem? c. How does the Internet, which makes freely available all sorts of information about diseases and their treatments, affect the physician-patient relationship?

Suppose there are four boats available at an auction. The sellers know the quality of their boats but the prospective buyers do not. The buyers know that two of the boats are high quality and two of the boats are low quality. Buyers value high-quality boats at $100,000 and low-quality boats at $60,000. Sellers value high-quality boats at $80,000 and low-quality boats at $40,000. If the auctioneer sets a price per boat at $50,000, how many boats and of which type will sellers make available?

Which of the following is (are) examples of moral hazard? I. An unemployed worker reduced his effort to find a job after he became eligible for unemployment insurance. II. Banks make exceptionally risky investments because they expect government bailouts if their investments fail. III. After a university made the morning-after pill available on campus, more students became sexually promiscuous.

In the market for karate lessons, the instructors know more about the quality of their instruction than their students do. This situation may set up a:

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, ____ low-quality used kayaks will be sold.

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. Without insurance coverage, Paula will make ____ physician visits.

(Figure: Theft Prevention) An individual who buys full-coverage automobile insurance will choose to take _____ unit(s) of action to prevent theft.

Kulap, a soybean farmer, acts to prevent crop failure. The marginal benefit is represented by MB = 80 - A, where A is the number of precautions. The marginal cost of these precautions (e.g., soil preparation and pesticide and fertilizer use) is MC = 20 - 0.5A. Suppose the government offers Kulap crop insurance, which changes the marginal benefit of taking precautions to MB = 65 - 2A. The number of precautions Kulap takes _____ from _____ without insurance to _____ with insurance.

Many states have laws requiring that health insurance policies cover the treatment of diabetes. One study found that after the passage of these laws, diabetics became fatter, which complicates the treatment. This study's finding is an example of:

(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 $1,000, buyers value the cars for sale at $____ each.