Deck 20: Assymetric Information and Market Behaviour

Question 1

Firms engage in useless advertising because:

A)they are trying to keep out rival firms.
B)they are trying to play with your mind.
C)they are demonstrating that they have invested in sunk assets.
D)they want you to like the ad so that you will like the product.

Answer 1

they are demonstrating that they have invested in sunk assets.

Question 2

The fact that young job seekers have a hard time obtaining a job they have no experience with:

A)indicates blatant discrimination by the employers.
B)should be made illegal.
C)is understandable at the beginning of a career.
D)is an example of adverse selection.

Answer 2

is an example of adverse selection.

Question 3

In order for a firm to produce high quality goods in an asymmetric information market with high and low quality producers:

A)the present value of revenue must be positive.
B)the present value of profits has to be higher than the costs of operating.
C)the present value of the premium for high quality goods must be higher than the gain from cheating.
D)the present value of cheating must be higher than the gain from producing high quality goods.

Answer 3

the present value of the premium for high quality goods must be higher than the gain from cheating.

Question 4

Signaling:

A)is a method of solving moral hazard problems.
B)benefits the sellers of low quality goods.
C)involves a pure transfer of wealth from employers to employees.
D)is a method of solving an adverse selection problem.

Question 5

Making a productive sunk investment is superior to posting bond:

A)because only the investment guarantees an exchange.
B)neoclassical economics considers only cost as being important.
C)because it lowers the cost of building reputation.
D)because the overall productivity is enhanced.

Question 6

If the proportion of high risk drivers is not too high, then:

A)only low risk drivers will buy insurance.
B)only high risk drivers will buy insurance.
C)both high and low risk drivers will buy insurance.
D)neither low or high risk drivers will buy insurance.

Question 7

Moral hazard:

A)reflects the perverse incentives insured individuals have to act carelessly.
B)is about the immorality of lying.
C)implies that people buying insurance tend to be more thoughtful than those who do not.
D)is the danger believers might change their faith.

Question 8

Which of the following is a potential solution to the adverse selection problem?

A)marketing
B)blinking
C)screening
D)flashing

Question 9

Banks build expensive headquarters and use lavish interiors:

A)because they have too much money.
B)because bankers are big suckers for comfort.
C)in order to build a reputation for honesty.
D)in order to show off.

Question 10

Screening:

A)benefits the sellers of high quality goods.
B)has no direct costs.
C)is not a transaction cost.
D)is exactly the same as signaling.

Question 11

Whether all drivers buy insurance or only high- risk drivers buy insurance:

A)it is a function of the relative size of the two groups.
B)it is a function of how aggressive insurance companies market their policies.
C)it is a function if their risk preferences.
D)it is a function of their levels of wealth.

Question 12

Suppose there exists only one type of auto- insurance policy, and that all the individuals are
Risk- averse. Seventy- five percent of the population consists of low- risk individuals, each of whom has a 10% chance of being in a car accident that causes $5,000 worth of damage. The remainder of the population has a 60% chance of being in such an accident. Given a competitive insurance market consisting of risk- neutral firms that incur no operating expenses, what will be the equilibrium price for full coverage?

A)$525
B)$1,125
C)Either $3,000, or $1,125
D)$3,000

Question 13

Some drivers are low risk and other are high risk because:

A)the probability of loss from collision is different across drivers.
B)of inherent discrimination in our society.
C)drivers lie about their risk characteristics to insurance companies.
D)insurance companies can costlessly assess drivers' risk characteristics.

Question 14

By establishing a reputation for high quality products, a firm:

A)is earning a higher rate of return than otherwise.
B)responds to asymmetric information between buyers and sellers.
C)is maximizing profits.
D)sets up the customers for future cheating.

Question 15

Which of the following is a potential solution to the adverse selection problem?

A)signalling
B)flashing
C)marketing
D)blinking

Question 16

Newspapers usually own their printing presses while magazines generally do not because:

A)they take advantage of economies of scale.
B)they are richer and can afford it.
C)they might experience hold- up problems.
D)there is more competition in their market.

Question 17

A hold- up problem is:

A)when a firm tries to capture the rents caused by a sunk investment.
B)when you get robbed.
C)when a firm demands more money for completing a task.
D)when nature prevents you from completing a task.

Question 18

Sugar farmers almost always jointly own local sugar mills:

A)because rich people own all the factors of production in developing countries.
B)big vertically integrated firms make more profit.
C)because of the hold- up problem.
D)since most of these industries are monopolized.

Question 19

Which of the following is not a form of signalling?

A)a contract
B)a warranty
C)a guarantee
D)a university degree

Question 20

In the case of the insurance equilibrium with low and high risk drivers, market failure represents:

A)the choice by high- risk drivers to buy insurance.
B)low premiums.
C)the choice by low- risk drivers not to buy insurance.
D)the choice by low- risk drivers to buy insurance.

Question 21

The meaning of "skimming the cream" in car insurance markets refers to:

A)offering low rates to low- risk drivers.
B)denying coverage to high- risk drivers.
C)denying coverage to low- risk drivers.
D)offering high rates to high- risk drivers.

Question 22

The term adverse selection refers to a situation where:

A)people who buy insurance need it.
B)most people don't need insurance.
C)people are over- insured.
D)most people are poor insurance risks.

Question 23

Under which of the following situations might the problem of adverse selection occur?

A)Transaction costs are low.
B)Information is costlessly communicated.
C)The individuals have heterogeneous probabilities of actual losses.
D)Individuals are homogeneous in their attitude toward risk.

Question 24

Hostage capital cannot exist:

A)when a firm only has variable costs.
B)if the firm is careful about its operations.
C)where there are no sunk costs.
D)in a democracy.

Question 25

Figure 20A

The cheating strategy for a firm in Figure 20A is at:

A)point A.
B)point B.
C)point C.
D)point 0.

Question 26

Which of the following is not an assumption of hidden characteristics in automobile insurance markets?

A)probability of loss from a collision is not uniform across drivers
B)all drivers are risk averse
C)each driver's completely informed about their own characteristics
D)drivers risk characteristics cannot be communicated to insurance companies

Question 27

The fact that young job seekers have a hard time obtaining a job they have no experience with:

A)reflects the inability of any prospective worker to make claims regarding the ability to perform on the job.
B)has little to do with adverse selection.
C)is related to the ability of employers to gauge the prospective employees' characteristics.
D)reflects the difficulty in conveying the fact that they can do the job to the prospective employer.

Question 28

The market price for the insurance policy in the case of prohibitive costs of identifying each driver's risk characteristics is determined by:

A)the relative skills of the low- risk drivers.
B)the relative size of the high- risk and low- risk groups of drivers.
C)the relative skills of high- risk drivers.
D)the relative size of the group of new drivers.

Question 29

A firm can signal its commitment to produce high quality by:

A)purchasing sunk capital.
B)producing a large quantity.
C)setting a high price.
D)producing high quality goods.

Question 30

The situation where only high risk drivers buy insurance is called:

A)the socially optimal equilibrium.
B)information failure.
C)market failure.
D)insurance failure.

Question 31

The lemons principle exists when:

A)it is costly to tell different qualities.
B)it is costly to tell if some workers are working harder than others.
C)transaction costs are zero.
D)a pooling contract is not feasible.

Question 32

A pooling contract:

A)is the contract offered to all types of people in an insurance market.
B)can never be a bona fide equilibrium.
C)refers to the deal signed with the pool services worker.
D)is always preferred to discriminating contracts.

Question 33

Suppose that you are looking at to buy a used car and the value of that car is either $5000 or $10,000 with equal probability. If you cannot determine the true value of the car what is the maximum price you will offer?

A)$10,000
B)$7500
C)$5000
D)$6000

Question 34

Moral hazard problems occur because of:

A)hidden costs.
B)hidden actions.
C)hidden goods.
D)hidden characteristics.

Question 35

Young males often find car insurance expensive to get because:

A)young male drivers are all poor drivers.
B)young male drivers make up the majority of speeders.
C)insurance companies cannot tell what type of driver they'll be.
D)young male drivers are responsible for most accidents.

Question 36

One solution to the moral hazard problem is:

A)credible commitments.
B)credible insurance.
C)credible statements.
D)credible actions.

Question 37

Signalling is:

A)the same as screening.
B)ubiquitous.
C)an art.
D)very costly.

Question 38

The parents of a teenager with a drinking problem would not lend her their car because:

A)it is immoral to do so.
B)of moral hazard.
C)it is illegal to do so.
D)they do not understand her plea.

Question 39

A plausible reason the price of new cars falls sharply when they are bought is that:

A)few high quality used cars are sold.
B)new car buyers pay too much for their cars.
C)used cars are unreliable.
D)the demand for used cars is weak.

Question 40

Veal cattle sold at an auction tend to be the Holstein breed because:

A)tradition plays an important role in the choice of breeds.
B)they provide the best veal.
C)only dairy farmers can feed their calves so much milk.
D)their breed provides a cheap signal of quality.

Question 41

Marriage:

A)involves sunk investment made mostly by the father.
B)is becoming irrelevant in western societies.
C)can be interpreted as a long- term contract in the production of children.
D)is at odds with property division laws.

Question 42

Banks have elaborate buildings and expensive interiors because they:

A)are seeking to establish reliable reputations.
B)are seeking to attract big business.
C)make too much money.
D)are seeking to abscond with customers' money.

Question 43

A signal only works when:

A)the high quality types acquire the signal at higher cost than the low quality types.
B)the low quality types can also use the signal.
C)the high quality types acquire the signal at lower cost than the low quality types.
D)the high quality types acquire the signal at a high cost.

Question 44

By offering a discount to young drivers graduating from a reputable driver education program:

A)insurance companies set up a signalling equilibrium.
B)insurance companies eliminate discrimination among drivers.
C)insurance companies collude with driving school.
D)insurance companies erase the difference between low- risk and high- risk drivers.

Question 45

Skimming the cream:

A)means that a firm takes only the best of a group.
B)benefits all firms.
C)allows markets to offer everyone the same contract.
D)is a farming term.

Question 46

Ads with no informational content:

A)waste valuable resources.
B)are meant to build reputation.
C)transmit subliminal urges to buy the good.
D)try to make the customer feel good about herself.

Question 47

Figure 20A

In the situation of asymmetric information shown in Figure 20A, the firm's dominant strategy is to produce at:

A)point A.
B)point B.
C)point C.
D)point 0.

Question 48

Punishing a dishonest firm by shopping somewhere else is likely to:

A)have no effect on the behaviour of the firm.
B)create losses for the dishonest firm.
C)cause other firms to think twice about cheating.
D)cause the dishonest firm to make amends.

Question 49

If a firm produces high- quality goods and has extensive quality control mechanisms in place why do they offer warranties?

A)all firms offer warranties and that is the Nash equilibrium
B)consumers won't purchase goods without warranties
C)consumers don't fully understand product quality
D)a warrantee is a signal to the market

Question 50

In the equilibrium solution where all drivers buy insurance:

A)good drivers subsidize the insurance purchases of good drivers.
B)bad drivers pay the most for insurance.
C)bad drivers subsidize the insurance purchases of good drivers.
D)each driver pays the correct price for their insurance.

Question 51

In a world of imperfect information, an economic reason students go to college is to:

A)pool their risk of unemployment.
B)reduce their uncertainty about the future.
C)signal their abilities to employers.
D)acquire more information.

Question 52

In the case in which all drivers buy insurance:

A)high- risk drivers subsidize the insurance purchases of low- risk drivers.
B)the government subsidizes insurance premiums.
C)low- risk drivers subsidize the insurance purchases of high- risk drivers.
D)experienced drivers subsidize new drivers.

Question 53

The lemons principle

A)indicates that jewels can pass as lemons.
B)indicates that lemons can pass as jewels.
C)has the moral hazard problem at it root.
D)states that making good lemonade is as tough as learning economics.

Question 54

Banks are known for having elaborate buildings and expensive interiors. How can economics explain this phenomenon?

A)this is an investment in sunk costs to overcome a symmetric information
B)banks are heavily subsidized by the government
C)banks have low marginal costs and invest in fixed assets to reduce taxes
D)banks are generally large and have many shareholders none of whom have an incentive to monitor management

Question 55

Which of the following is not an example of sunk costs?

A)advertising
B)locate the firm is a huge warehouse.
C)spending money in the community
D)undertake costly actions to inform customers about itself

Question 56

The hold- up problem:

A)refers to the the incentives to appropriate economic rents.
B)refers to various problems delaying production.
C)is the main reasons for bridges not being built.
D)refers to the banks at risk of being robbed.

Question 57

Mules were used in South U.S. agriculture rather than the North because:

A)the climate was more friendly there.
B)there were more farm workers in the South who were not residual claimants.
C)their marginal product was higher in the South.
D)there were more farmers in the South.

Question 58

When an insurance company offers a single contract to all types of people it is called:

A)a pooling contract.
B)a full insurance contract.
C)an equilibrium contract.
D)a perfect information contract.

Question 59

The moral hazard problem refer to:

A)the presence of hidden actions.
B)the presence of hidden actions or characteristics.
C)the presence of hidden characteristics.
D)the presence of hidden action and characteristics.

Question 60

The relevant hidden characteristic for an insurance company is:

A)the probability of driving everyday.
B)how expensive each person's car is.
C)the probability of loss from an accident.
D)the number of miles a person drives.

Question 61

Which of the following is not a solution to the hold- up problem?

A)long- term contracts
B)horizontal integration
C)reputation.
D)vertical integration

Question 62

In an economic model, reputation:

A)is a mechanism used to guarantee quality.
B)is based on goodwill.
C)is not related to asymmetric information.
D)does not rely on past experiences.

Question 63

Moral hazard:

A)results when one firm tries to skim the cream.
B)means that individuals hide a characteristic about themselves.
C)is a transaction cost.
D)is an old religious term.

Question 64

Market failure in insurance markets can be overcome if

A)if higher risk drivers promise to be safer
B)if the government takes over the insurance market
C)there is a signal that only low cost drivers can attain
D)there is a signal that is very costly for high- risk drivers

Question 65

Skimming the cream:

A)is something you do to make butter.
B)is where a firm offers a contract that only the good workers will take.
C)is where the average quality of goods sold is high.
D)is where a firm takes only those workers that work hard.

Question 66

Which of the following is likely a result of adverse selection?

A)Young women pay less for automobile insurance than young men.
B)New life insurance policies have a one- year suicide exclusion.
C)Smokers pay more for life insurance than nonsmokers.
D)Employment insurance premiums increase with income.

Question 67

Vertical integration refers to:

A)mergers taking place in industries subject to double hold- ups.
B)merging with a competitor.
C)merging taking place among multinationals.
D)merging with a firm upstream.

Question 68

Which of the following is and example of a market failure caused by asymmetric information?

A)The generation of electricity from fossil fuels creates an externality.
B)Automobile dealers offer warranties on their used cars.
C)Low risk individuals choose not to buy insurance.
D)High risk individuals pay higher premiums than low risk individuals.

Question 69

Firms might not commit to spending sunk costs because of:

A)the property rights problem.
B)the bankruptcy problem.
C)the free rider problem.
D)the hold- up problem.

Question 70

Individuals with rare illnesses are often unable to get health insurance because:

A)insurance companies have no compassion.
B)there are not enough of them to cause people to care.
C)they can hide their illness and get insurance at rates for healthy people.
D)firms can't make money with only a few customers.

Question 71

The lemons principle refers to the situation where:

A)neither type of good is offered on the market.
B)high quality goods are never offered on the market.
C)low quality goods are never offered on the market.
D)low quality and high quality goods are sold in the same market.

Question 72

Which of the following explains why banks are decorated with marble floors, brass fittings, exterior pillars and elaborate lighting?

A)Adverse selection
B)Moral hazard
C)Incentive compatibility
D)Government regulation

Question 73

Vertical integration:

A)is illegal in Canada.
B)is not a solution to the hold- up problem.
C)is accomplished via long- term contracts.
D)is subject to transaction costs.

Question 74

Employers that require applicants to have a university degree want employees that:

A)know how to read signals.
B)have a lower cost of learning.
C)are trained in the job that the firm is hiring for.
D)have shown that they don't really need the money.

Question 75

The officers of the cavalry owned their own horses because:

A)the army was too poor to buy them.
B)it was more efficient given the large turnover.
C)officers could not trust the army to buy quality horses.
D)it provided them with good incentives to look after them.

Question 76

Signalling:

A)redistributes wealth from the high- risk type to the low- risk type.
B)redistributes wealth from the low- risk type to the high- risk type.
C)destroys wealth since acquiring the signal is costly.
D)creates wealth by creating a new market.

Question 77

A reputation must involve investments in sunk assets because:

A)this eliminates profits without incurring entry.
B)sunk costs still encourage some cheating, but not much.
C)avoidable cost investments will not increase the AC curve.
D)consumers can recognize the investment.

Question 78

A market failure may occur in insurance markets when

A)low risk drivers subsidize high- risk drivers
B)when insurance companies discriminate on the basis of risk
C)when insurance is not fairly priced
D)low risk drivers do not buy insurance

Question 79

Firms with reputational capital still earn zero profits because:

A)otherwise they would produce low quality goods.
B)otherwise there would be entry into the market.
C)otherwise they would earn a rent.
D)otherwise they would be dishonest.

Question 80

A young would- be employee that knows it can do the job:

A)is showing confidence and usually get the job.
B)is in the same position as an unskilled and incapable would- be employee.
C)is in the same position as an inexperienced employee that performed on- the- job training.
D)cannot always find a way to convey this information to the potential employer.