Deck 12: Information and Behavioural Economics

Question 1

In the real world, people always behave rationally when making economic decisions.

Answer 1

False

Question 2

Which of the following would be an example of a principal trying to deal with a moral hazard problem?

A) The parents of an infant secretly place video cameras in their house before the baby-sitter arrives.
B) An insurance company checks police records to determine if its policyholders have received traffic fines.
C) An employer examines his workers' output on a daily basis.
D) All of the above are correct.

Answer 2

All of the above are correct.

Question 3

Moral hazard occurs when

A) the principal monitors an agent.
B) two people might trade with each other, and one person has relevant information about some aspect of the product's quality that the other person lacks.
C) an agent lacks an incentive to promote the best interests of the principal, and the principal cannot observe the actions of the agent.
D) an agent monitors the principal.

Answer 3

an agent lacks an incentive to promote the best interests of the principal, and the principal cannot observe the actions of the agent.

Question 4

The principal-agent problem arises because of

A) the firm's motive for profit maximisation.
B) the salary differential between management and labourers.
C) the structure of the market in which the firm operates.
D) conflicting interests between a principal and an agent.

Question 5

Since people tend to care about fairness, firms may give bonuses during particularly profitable years to be fair and to avoid retaliation from the workers.

Question 6

Which of the following relationships involves asymmetric information?

A) An employee knows more than his employer knows about his work effort.
B) A borrower knows more than the lender about his ability to repay the loan.
C) The seller of a 30-year-old house knows more than the buyer about the condition of the house.
D) All of the above are correct.

Question 7

In the principal-agent relationship, the principal performs a task on behalf of the agent.

Question 8

The field of behavioural economics builds a more subtle and complex model of economic behaviour using insights from

A) physics.
B) biology.
C) psychology.
D) anthropology.

Question 9

The fact that someone with a high risk of medical problems is more likely to buy a lot of health insurance is an example of something that will give rise to

A) adverse selection.
B) monitoring.
C) moral hazard.
D) irrational behaviour.

Question 10

A person's tendency to smoke a cigarette after promising to quit is an example of the behavioural economics insight that people are inconsistent over time.

Question 11

When one party is better informed about an economic situation than another party, economists describe the problem as one of

A) asymmetric information.
B) moral hazard.
C) political economy.
D) behavioural economics.

Question 12

Which of the following relationships involves asymmetric information?

A) Patients can look up information regarding certain prescription drugs giving them the same information as their doctors.
B) Consumer Reports allows customers of DVD players to know as much about the quality of various players as the store salesperson.
C) CarCheck allows car buyers to obtain used vehicle histories, providing them with the same information as the dealership salesperson.
D) The goalkeeper in a soccer game must guess whether the penalty taker will shoot to the goalkeeper's right or left side.

Question 13

The ultimatum game demonstrates that people will always make choices according to their self-interest.

Question 14

Mandla, who knew nothing about construction, paid Shaun to build an extension on his house. Two years later, a wall of the new extension crumbled because Shaun used poor quality materials. This is an example of

A) adverse selection.
B) screening.
C) moral hazard.
D) signalling.

Question 15

Asymmetric information is a problem that occurs when one person in a transaction knows more about what is going on than the other.

Question 16

To avoid the problem of adverse selection, insurance companies screen their prospective customers to discover hidden health problems.

Question 17

People seem to naturally engage in delayed gratification and they tend to follow through plans made today to do something unpleasant in the future.

Question 18

Signals to convey high quality are most effective when they are costless to all firms in the industry.

Question 19

The principal-agent problem is more serious in large firms than in small firms because

A) monitoring employee activity in large firms is generally more difficult.
B) employees in large firms have less information.
C) profits increase with the size of the firm.
D) customers expect better treatment from small firms and they usually get it.

Question 20

Employers may pay higher than equilibrium wages to avoid moral hazard in the employment relationship by raising the cost of shirking.

Question 21

Because people with hidden health problems are more likely to buy health insurance than are other people,

A) the price of health insurance reflects the costs of a sicker-than-average person.
B) the price of health insurance is too low, relative to the socially-optimal price.
C) people in average health may be encouraged to buy too much health insurance, relative to the socially-optimal quantity.
D) the Condorcet Paradox suggests that people who are sicker than average will ultimately buy more health insurance.

Question 22

Which of the following is not a method firms use to avoid the moral hazard problem in the employment relationship? They:

A) pay employees with delayed compensation such as a year-end bonus.
B) buy life insurance on their workers.
C) pay above equilibrium wages.
D) put hidden video cameras in the workplace.

Question 23

Which of the following is an example of a signal that is used to reveal private information?

A) Erick carefully chooses a special gift for Suzanne.
B) Henry graduates from university.
C) Lexus advertises its cars during the Soccer World Cup Final.
D) All of these answers are correct.

Question 24

An apparel company employs Jabulile as a designer. In this employment relationship, the apparel company is the

A) agent.
B) principal.
C) screener.
D) signaller.

Question 25

Which of the following best demonstrates the problem of moral hazard?

A) Cynthia doesn't buy health insurance because it is too expensive and she is healthy.
B) A life insurance company forces Tebogo to have a medical examination prior to selling her insurance.
C) Lerato drives more recklessly after she buys car insurance.
D) Fatima chooses to attend a well-respected university.

Question 26

Markus is a travelling salesman for an insurance company. In this employment relationship, Markus is the

A) agent.
B) principal.
C) screener.
D) signaller.

Question 27

Moral hazard occurs when

A) an employer closely monitors an employee.
B) two people consider a trade with each other and one person has relevant information about some aspect of the product's quality that the other person lacks.
C) an employee lacks an incentive to promote the best interests of the employer, and the employer cannot observe the actions of the employee.
D) an employee closely monitors the actions of her employer.

Question 28

Jan's car is in need of repair, so Jan decides to sell it to avoid the repair bill. Unaware of the problem, Pieter buys the car. This is an example of

A) hidden actions.
B) adverse selection.
C) efficiency wages.
D) moral hazard.

Question 29

Yusuf is planning to sell his home. In preparation for the sale, he paints all of the ceilings in his house to cover up water stains from his leaking roof so that potential buyers will be unaware of this problem. This is an example of

A) moral hazard.
B) screening.
C) adverse selection.
D) the principal-agent problem.

Question 30

Severe adverse selection problems may result in

A) too few good used cars being offered for sale.
B) wages that are too low relative to equilibrium levels.
C) too many good drivers buying too much car insurance.
D) people with average health buying too much health insurance.

Question 31

Your friend works at a coffee shop on campus and regularly gives away free coffee to you and your friends when you visit. This is an example of

A) a moral hazard problem.
B) adverse selection.
C) behavioural economics.
D) signalling.

Question 32

Which of the following is not an example of signalling?

A) Screening.
B) Advertising.
C) Getting an education.
D) Gift giving.

Question 33

Frequently it is the case that: (1) A worker knows more than his employer about how much effort he puts into his job, and (2) the seller of a used car knows more than the buyer about the car's condition.

A) Neither (1) nor (2) serves as an example of asymmetric information.
B) Both (1) and (2) serve as examples of asymmetric information.
C) Neither (1) nor (2) serves as an example of a hidden action.
D) Both (1) and (2) serve as examples of hidden action.

Question 34

Which of the following offers an explanation as to why the principal-agent problem exists for a firm?

A) The firm cares less about profit and more about cost when there are many competitors in the market.
B) The firm offers an employee-incentive program in which employees share in the firm's profits.
C) The firm operates in a market with many competitors forcing the firm to pay its employees more to keep them from switching to another firm.
D) The firm operates to maximise profit while the employees attempt to work as little as possible to earn their paychecks.

Question 35

Ricky goes to work 8 hours per day, but while he is at work he spends most of his time visiting internet sites monitoring his fantasy football teams. This is an example of

A) hidden characteristics.
B) signalling.
C) moral hazard and hidden action.
D) screening.

Question 36

Nicole wants to avoid buying a car with hidden defects. She takes a car she would like to buy to her mechanic before she purchases it. This is known as

A) screening.
B) signalling.
C) moral hazard.
D) adverse selection.

Question 37

A woman gives her boyfriend a birthday present. The gift could be viewed by the boyfriend as a

A) moral hazard problem.
B) screening device.
C) signal of how much she cares for him.
D) All of the above are correct.

Question 38

Which of the following must be true about a signal that is used to reveal private information in order for the signal to be effective? It must be:

A) "as seen on TV."
B) free to the signalling party.
C) costly to the signalling party but less costly to the party with the higher-quality product.
D) applied to an inexpensive product.

Question 39

Effective signals

A) convey useful information from informed parties to uninformed parties.
B) impose little or no cost on the signaller.
C) cannot be conveyed accurately when there is an information asymmetry.
D) can be used by employers to alleviate the moral hazard problem in the workplace.

Question 40

Which of the following is an example of an adverse selection problem?

A) A customer purchases four apples, two of which are bruised.
B) A card shop puts its Halloween merchandise on sale after Halloween.
C) A young worker is fired after she is late for work three times in one month.
D) A man whose father had a heart attack wants to increase his life insurance coverage.

Question 41

Explain how the ultimatum theory works and its likely results.

Question 42

Mfundo's friend dies of a sudden heart attack. Mfundo rushes to his doctor for an expensive physical examination. This response demonstrates that people

A) give too much weight to a small number of vivid observations.
B) easily change their minds when confronted with new information.
C) enjoy going to the doctor.
D) tend to plan ahead and follow through on their plans.

Question 43

Which of the following statements is not correct?

A) Based on studies of human decision-making, most people value fairness.
B) Based on studies of human decision-making, some people's preferences are inconsistent over time.
C) Government intervention is the best remedy for the problems caused by asymmetric information.
D) Advertising can be an example of a company signalling the quality of its products.

Question 44

Identify and explain the two basic types of problems that arise when there is asymmetric information.

Question 45

What is herd mentality?

Question 46

William is preparing to study for the economics final exam. William is happy to get an honours degree, even though he could likely earn his honours degree cum laude if he would study harder. William is a(n)

A) rational maximiser.
B) satisficer.
C) agent.
D) screener.

Question 47

In the ultimatum game, what split would be rational for both the person proposing the split and the person who must accept or reject the split?

A) There is no rational solution.
B) 75/25.
C) 99/1.
D) 1/99.
E) 50/50.

Question 48

Explain and provide examples of what is meant by "asymmetric information."

Question 49

If the seller of a used car offers a limited warranty, the warranty is an example of a(n)

A) signal.
B) screen.
C) efficiency wage.
D) agent.

Question 50

Which is an example of people trying to make better choices for themselves?

A) Take out a pension plan with monthly contributions to provide a better future pension.
B) Insist that your partner doesn't buy chocolate or sugary drinks when at the supermarket, to help with your diet plans.
C) Pay for gym membership and go regularly in order to improve your fitness.
D) All of the above.

Question 51

Explain how the presence of asymmetric information in car insurance markets may lead people who are good drivers or even average drivers to choose not to buy car insurance unless the law requires it.

Question 52

A mother gives her teenage daughter two choices: spend 20 minutes cleaning her room now or spend 25 minutes cleaning her room tomorrow. The same mother gives her same daughter two additional choices: clean out the garage for 20 minutes next Tuesday or 25 minutes next Wednesday. What are her likely choices?

Question 53

How does the prospect theory work?

Question 54

Provide three examples of screening.

Question 55

According to one survey most South Africans said they were not saving enough for retirement. This example of inconsistency over time

A) is rational behaviour.
B) likely occurs because saving requires a sacrifice in the present for a reward in the distant future.
C) likely occurs because South Africans don't care about retirement.
D) definitely would not happen if South Africans earned a greater return on their investments.

Question 56

How have insights from the field of psychology influenced the thinking of economists in recent years?

Question 57

Which of the following help explain why firms pay bonuses to workers during particularly profitable years to prevent workers from becoming disgruntled? People

A) are rational maximisers.
B) are reluctant to change their minds.
C) are inconsistent over time.
D) care about fairness.

Question 58

What is the purpose of signalling?

Question 59

The ultimatum game reveals that

A) it does not make sense to try to maximise profits.
B) people may have an innate sense of fairness that economic theory does not capture.
C) offering someone a wildly unfair outcome is usually acceptable since people tend to make decisions using a "something is better than nothing" philosophy.
D) Both a and b.

Question 60

Which of the following is a response to people's inconsistent behaviour over time?

A) All of these answers.
B) Forced contributions to a retirement plan.
C) Year-end bonuses.
D) Efficiency wages.