Deck 16: The Economics of Information

Question 1

Which of the following is likely to happen in a used car market if the buyers feel that the best they can do is buy a lemon?

A) The sellers of high-quality used cars will reap high profits.
B) Higher gains from trade will be realized.
C) The entire market will shut down.
D) The sellers of lemons will earn high profits.

Answer 1

The entire market will shut down.

Question 2

You went to a craft show and paid an exorbitant price for an embroidered shawl that the seller said was hand embroidered and had been imported from India.Several months later,you found a similar shawl in another showroom at a much lower price and realized that the one you bought was not imported.This is an example of a market with ________.

A) asymmetric information
B) a positive externality
C) a negative externality
D) the free-rider problem

Answer 2

asymmetric information

Question 3

A fruit retailer buys 50 pounds of apples from the wholesale market every day.The retailer has observed that 20 percent of the apples bought each time are not good quality.Because it is not possible for the retailer to check each apple before buying them,how much should he pay for each pound if he values good apples at $1.40 per pound and bad apples at $0 per pound?

A) $1.12 per pound
B) $1.20 per pound
C) $1.40 per pound
D) $2 per pound

Answer 3

$1.12 per pound

Question 4

Which of the following is true of a used car market?

A) The sellers have more information than the buyers.
B) Gains from trade do not exist in the market.
C) The cars sold are identical in quality.
D) There is no consumer surplus in the market.

Question 5

Scenario: You walk into a used car lot to buy your first car. However, you are not sure of the quality of the cars in the lot and expect one-third of them to be of poor quality.
Refer to the scenario above.Suppose you decide to buy a Toyota Corolla.You value the car at $10,000,but the car dealer values it at $8,500,which is not known to you.Which of the following is likely to be true?

A) You will end up buying a high-quality car.
B) You will end up buying a poor-quality car.
C) You will end up earning a positive consumer surplus.
D) You will choose not to buy the car.

Question 6

In a market with ________,one side of the market has private information that is relevant for the other side.

A) asymmetric information
B) perfect competition
C) monopolistic competition
D) positive externalities

Question 7

Distinguish between two kinds of asymmetric information.

Question 8

Asymmetric information in a market can lead to ________.

A) market failure
B) the moral hazard problem
C) the free-rider problem
D) the tragedy of the commons

Question 9

Which of the following is an example of adverse selection?

A) Overgrazing of a common piece of land
B) A passenger traveling in a subway without a ticket
C) A customer buying a defective appliance from a used goods market
D) The generation of hazardous waste by the production of a good

Question 10

Mr.Smith put his laptop up for sale.He was aware of the fact that the laptop malfunctioned frequently.However,none of the potential customers who came to buy the laptop were able to discover the problem.One of them actually bought it at a remunerative price.This occurred because of the presence of ________.

A) asymmetric information
B) positive externalities
C) negative externalities
D) the moral hazard problem

Question 11

Scenario: You walk into a used car lot to buy your first car. However, you are not sure of the quality of the cars in the lot and expect one-third of them to be of poor quality.
Refer to the scenario above.You are eager to pay $10,000 for a good-quality car but $0 for a poor-quality car.Suppose you decide to buy a Toyota Corolla that the car dealer values at $8,500.What is the most that you would be willing to pay for the car?

A) $3,000.50
B) $6,666.67
C) $10,000
D) $5,000

Question 12

Claudia went to a department store to buy a few things for her new house.She found that several items in the store were on discount and decided to make the most of the deals offered.However,when she started using the things that she bought on discount,she realized that many of them were defective.This happened because of the presence of ________.

A) positive externalities
B) negative externalities
C) asymmetric information
D) the moral hazard problem

Question 13

In a market with asymmetric information,a good is said to have hidden characteristics if ________.

A) the consumption of the good imposes an additional cost on society
B) the production of the good generates additional benefits to society
C) the seller offers secret discounts to some buyers of the good
D) the buyer or the seller observes something about the good that the other does not

Question 14

In a market with asymmetric information,________.

A) people tend to overuse a resource is such a way that it gets exhausted
B) people with an informational disadvantage experience positive externalities
C) buyers and sellers have different information about the good being traded
D) sellers have very low bargaining power

Question 15

Scenario: You walk into a used car lot to buy your first car. However, you are not sure of the quality of the cars in the lot and expect one-third of them to be of poor quality.
Refer to the scenario above.Suppose you decide to buy a Toyota Corolla.You value the car at $10,000,but the car dealer values it at $8,500,which is not known to you.What is the minimum price the seller will accept for the car?

A) $8,500
B) $7,000
C) $10,000
D) $5,000

Question 16

Scenario: Tom wants to buy a used iPhone from an online exchange Web site. He expects 50 percent of the used phones to have some defect. He is willing to pay up to $80 for a phone without any defect and $0 for a defective phone. An owner of a good-quality iPhone is likely to sell his phone if he gets a price of $70.
Refer to the scenario above.Which of the following problems is likely to occur in this market?

A) The fallacy of composition
B) Moral hazard
C) Adverse selection
D) The free-rider problem

Question 17

In a market with asymmetric information,hidden actions exist if ________.

A) the buyer or the seller takes actions that are relevant for, but not observed by, the other party
B) the production or consumption of a good gives rise to positive externalities
C) the production or consumption of a good gives rise to negative externalities
D) the value of a good to a seller is greater than its value to a buyer

Question 18

Scenario: You walk into a used car lot to buy your first car. However, you are not sure of the quality of the cars in the lot and expect one-third of them to be of poor quality.
Refer to the scenario above.Suppose you decide to buy a Toyota Corolla.You value the car at $10,000,but the car dealer values it at $8,500,which is not known to you.Which of the following is true in this case?

A) There are no gains from trade.
B) There are gains from trade.
C) The transaction will result in negative externalities.
D) The transaction will result in positive externalities.

Question 19

In a market with asymmetric information,gains from trade occur if ________.

A) the value of a good to a seller is greater than its value to a buyer
B) the value of a good to a buyer is greater than its value to a seller
C) the variable cost of producing a good is zero
D) the opportunity cost of consuming a good is zero

Question 20

Scenario: You walk into a used car lot to buy your first car. However, you are not sure of the quality of the cars in the lot and expect one-third of them to be of poor quality.
Refer to the scenario above.Based on the given information,we can conclude that the market for used cars has ________.

A) information asymmetry
B) a perfectly competitive structure
C) positive externalities
D) negative externalities

Question 21

Scenario: Tom wants to buy a used iPhone from an online exchange Web site. He expects 50 percent of the used phones to have some defect. He is willing to pay up to $80 for a phone without any defect and $0 for a defective phone. An owner of a good-quality iPhone is likely to sell his phone if he gets a price of $70.
Refer to the scenario above.Tom is likely to get a defective phone if he is willing to pay an amount of ________.

A) $80
B) $100
C) $40
D) $120

Question 22

________ discourage low-risk individuals from seeking health insurance.

A) Low premiums
B) High premiums
C) High costs of medical treatment
D) Low interest rates

Question 23

Scenario: The market for used cell phones is very popular in Barylia. However, several phones available in this market are of an inferior quality, and it is often impossible to differentiate between a good-quality phone and a poor-quality phone.
Refer to the scenario above.Based on the given information,we can conclude that the market for used cell phones in Barylia ________.

A) has asymmetric information
B) is perfectly competitive
C) is monopolistically competitive
D) has the free-rider problem

Question 24

In which of the following markets are buyers likely to have private information?

A) The market for used cars
B) The market for fresh fruits and vegetables
C) The market for banking services
D) The market for health insurance

Question 25

Scenario: The market for used cell phones is very popular in Barylia. However, several phones available in this market are of an inferior quality, and it is often impossible to differentiate between a good-quality phone and a poor-quality phone.
Refer to the scenario above.Which of the following problems is likely to arise in the market for used cell phones in Barylia?

A) The tragedy of the commons
B) The paradox of thrift
C) Adverse selection
D) Moral hazard

Question 26

Scenario: Mike wants to buy an ancient painting from a curator. Mike values the original painting at $50,000, while he does not have any value for a fake one. However, he cannot differentiate between the original painting and a fake painting.
Refer to the scenario above.How much should he pay for the painting if he thinks that there is a 70 percent chance that the painting he is buying is original?

A) $50,000
B) $35,000
C) $70,000
D) $15,000

Question 27

Why do the owners of good-quality used cars stay away from the market for used cars?

Question 28

Health insurance companies often charge high premiums because they expect to attract ________.

A) high-risk individuals
B) risk-averse individuals
C) low-income individuals
D) risk-neutral individuals

Question 29

Sarah went to a store to buy a used camera.She was looking at different models when the store manager asked her about the maximum price that she would pay.Because it was impossible to know the quality of the cameras,Sarah lowered her willingness to pay to $200,although she valued a used camera of good quality at $300.If the seller values a camera of good quality at $250,what is most likely to happen in this case?

Question 30

Ted went to the market to buy Good X.He was willing to pay up to $2.50 per unit of the good.However,he expected some units of the good to be defective.Therefore,when the seller asked a price of $2.30 per unit,he refused to pay more than $2 for each unit.If the seller knows which units of the good are defective,what is most likely to happen in this case?

Question 31

How can a buyer of car insurance help reduce the effects of adverse selection?

Question 32

Adverse selection arises in the health insurance market because ________.

A) buyers have private information
B) sellers have private information
C) different firms provide different insurance schemes
D) the number of buyers and sellers is large

Question 33

Scenario: Mike wants to buy an ancient painting from a curator. Mike values the original painting at $50,000, while he does not have any value for a fake one. However, he cannot differentiate between the original painting and a fake painting.
Refer to the scenario above.If the curator values the painting at $45,000,which of the following problems is likely to arise?

A) Adverse selection
B) The free-rider problem
C) The paradox of thrift
D) The tragedy of the commons

Question 34

Which of the following is a problem that arises in a health insurance market?

A) There are a large number of buyers of various insurance programs.
B) A fierce competition exists between insurance providers.
C) A disproportionate number of high-risk individuals tend to buy insurance.
D) Only risk-averse individuals buy insurance.

Question 35

________ occurs when one agent in a transaction knows about a hidden characteristic of a good.

A) The free-rider problem
B) The tragedy of the commons
C) Adverse selection
D) The moral hazard problem

Question 36

Health insurance markets are likely to attract a disproportionate number of ________ individuals.

A) high-risk
B) risk-seeking
C) low-risk
D) risk-averse

Question 37

80 percent of the total number of people in Genovia with health insurance are more than 40 years old.Which of the following economic concepts helps explain this fact?

A) The concept of negative externalities
B) The concept of adverse selection
C) The concept of free riding
D) The concept of positive externalities

Question 38

Paul is looking for a used washing machine.He has posted his requirement on an online exchange Web site and has also mentioned the maximum amount that he is willing to pay for it.If his willingness to pay is lower than the price of good-quality used washing machines,what is likely to happen?

Question 39

Scenario: Tom wants to buy a used iPhone from an online exchange Web site. He expects 50 percent of the used phones to have some defect. He is willing to pay up to $80 for a phone without any defect and $0 for a defective phone. An owner of a good-quality iPhone is likely to sell his phone if he gets a price of $70.
Refer to the scenario above.In this case,how much should Tom pay for a used iPhone?

A) $80
B) $40
C) $60
D) $0

Question 40

A factory urgently needs to hire some workers.The factory owner is willing to pay a wage of $15 per hour to responsible workers and is unwilling to hire workers who require constant monitoring.On average,he expects five out of the ten workers who have come for the interview to be sincere.How much should he offer to pay the workers he hires?

A) $15 per hour
B) $7.50 per hour
C) $10 per hour
D) $8 per hour

Question 41

You decide to carry a letter of recommendation from your college professor to your first interview.This is an example of ________.

A) sniping
B) signaling
C) hedging
D) speculating

Question 42

Which of the following is an example of signaling in a market with asymmetric information?

A) The certification of used cars by third parties
B) Rent controls imposed by government
C) Discounts offered by sellers during the holiday season
D) The taxation of alcoholic beverages

Question 43

A warranty is an example of ________.

A) sniping
B) signaling
C) a price floor
D) a price ceiling

Question 44

Why do insurance companies in many developing countries not offer full health insurance coverage to older applicants?

Question 45

Which of the following is a market-based solution to the problem of adverse selection?

A) Corrective taxes
B) Signaling
C) Hedging
D) Corrective subsidies

Question 46

Which of the following helps reduce the problem of adverse selection in health insurance markets?

A) Signaling
B) High premiums
C) High rates of taxation
D) Patents

Question 47

Why do health insurance companies ask their potential customers to submit their previous medical records?

Question 48

What is signaling?

Question 49

A study conducted by a research firm revealed that RiteCure Health Insurance charges higher premiums than most of its rivals.The study also revealed that unlike its rivals,60 percent of RiteCure's customers have chronic illnesses.
a)What is the link between these two findings?
b)What is likely to happen if the premium continues to rise?

Question 50

Which of the following is a prominent solution to adverse selection in used car markets?

A) Well-defined property rights of citizens
B) The imposition of a price ceiling in the used car market
C) The imposition of a price floor in the used car market
D) Third-party certification of used cars

Question 51

Signaling takes place in markets with ________.

A) asymmetric information
B) positive externalities
C) negative externalities
D) a principal-agent problem

Question 52

The used car market has a significant amount of adverse selection because ________.

A) the seller knows more about the car than the buyer
B) the buyer can easily find out more about the car than the seller
C) buyers and sellers rarely have enough information about the car
D) the transaction costs of the used car market are prohibitively high

Question 53

Because warranties are potentially ________,low-quality goods are ________ to have warranties.

A) very expensive; less likely
B) inexpensive; less likely
C) very expensive; more likely
D) inexpensive; more likely

Question 54

________ refers to an action that an individual with private information takes to convince others about her information.

A) Sniping
B) Signaling
C) Hedging
D) Speculating

Question 55

Which of the following is likely to be used as a signal in the job market?

A) A job description
B) The educational qualification of an applicant
C) The letter of appointment
D) Vacancy announcements

Question 56

What,according to Akerlof,causes the price difference between a 1-year-old used car and an unsold car manufactured by the same company in the same year?

Question 57

Robert decided to purchase a health insurance plan but did not mention in the application form that his family has a history of heart ailments that are hereditary.What will happen if several customers like Robert purchase the insurance?

Question 58

Samsung provides a warranty for all goods it manufactures to indicate that these goods are of high quality.This is an example of ________.

A) hedging
B) signaling
C) internalizing an externality
D) sniping

Question 59

________ are guarantees of quality issued directly by either the manufacturer or the seller of goods.

A) Patents
B) Trademarks
C) Warranties
D) Copyrights

Question 60

To be useful as a signal in a market with asymmetric information,the signal must be ________.

A) easily available
B) inexpensive
C) tax deductible
D) costly to obtain

Question 61

Economists refer to the general problem of ________ as a principal-agent relationship.

A) moral hazard
B) adverse selection
C) negative externalities
D) pecuniary externalities

Question 62

Sarah initially used her cell phone mostly to make important business calls.However,when she was informed that henceforth her phone bills would be reimbursed by her employer,she started using her cell phone to make frequent calls to her friends and relatives.This behavior is an example of ________.

A) moral hazard
B) a negative externality
C) the prisoners' dilemma
D) the free-rider problem

Question 63

Mark works as a business development officer for a leading electronics company.His main task is to meet potential clients at their offices and set up business deals with them.Mark earns a fixed salary every month irrespective of the number of clients approached and deals made.As his boss does not cross-check the number of clients he meets in a day,Mark often does not meet all the clients that he is supposed to.His behavior is an example of ________.

A) adverse selection
B) moral hazard
C) a positive externality
D) a pecuniary externality

Question 64

Which of the following is likely to arise in a market with asymmetric information?

A) The problem of moral hazard
B) A pecuniary externality
C) A positive externality
D) A prisoners' dilemma

Question 65

Robert changed jobs and relocated to a new city.He initially decided to rent a small apartment close to his place of work.However,he decided to live in a much bigger and costlier apartment when he found that his employer would pay him a house rent allowance.This is an example of ________.

A) adverse selection
B) moral hazard
C) the prisoners' dilemma
D) the free-rider problem

Question 66

State provision of free healthcare may encourage individuals to engage in unhealthy behavior,such as excessive smoking or the consumption of alcohol.This is an example of ________.

A) moral hazard
B) a positive externality
C) adverse selection
D) anchoring

Question 67

Employee theft is an example of ________.

A) adverse selection
B) moral hazard
C) herd behavior
D) the internalization of externalities

Question 68

More people started building houses in the earthquake-prone regions of Polonia after its government launched a compensation scheme for houses damaged in earthquakes in these regions.This is an example of ________.

A) adverse selection
B) a positive externality
C) moral hazard
D) herd behavior

Question 69

The government of Perinthia provided generous unemployment benefits to all unemployed workers in the country.However,the new government that came into power reduced the amount of unemployment insurance paid to each worker.This increased the average number of hours that unemployed workers spent daily looking for jobs.This suggests that ________ exists in the labor market in Perinthia.

A) the problem of moral hazard
B) the tragedy of the commons
C) a pecuniary externality
D) a positive externality

Question 70

Sometimes banks tend to invest in risky stocks because the deposits of their customers are insured by the Federal Deposit Insurance Committee.This behavior is an example of ________.

A) adverse selection
B) moral hazard
C) the paradox of thrift
D) the free-rider problem

Question 71

Linda noticed that ever since her brother bought theft insurance for his car,he has been forgetting to lock his car.Her brother's behavior is an example of ________.

A) adverse selection
B) moral hazard
C) a positive externality
D) a pecuniary externality

Question 72

The basic idea behind moral hazard is that ________.

A) some economic transactions impose an additional cost on society
B) some economic transactions give rise to an additional benefit to society
C) people tend to take more risks if they do not have to bear the costs of their behavior
D) people do not reveal their true preference for goods that are non-excludable in consumption

Question 73

________ refers to actions taken by one party in a transaction that are relevant for,but not observed by,the other party.

A) A negative externality
B) Moral hazard
C) A positive externality
D) Bargaining

Question 74

Explain principal-agent relationships.

Question 75

Jane started eating more junk food and taking less care of her health after she bought a life insurance plan.Her behavior is an example of ________.

A) moral hazard
B) adverse selection
C) the paradox of thrift
D) the free-rider problem

Question 76

An employee in a department store often steals goods when other employees are not around.Because the store does not have a surveillance camera,the store manager is unable to monitor his activities.This behavior is an example of ________.

A) adverse selection
B) moral hazard
C) the internalization of externalities
D) the paradox of thrift

Question 77

Which of the following is likely to be an example of a principal-agent relationship?

A) The relationship between two colleagues
B) The relationship between a teacher and her student
C) The relationship between an employer and a worker
D) The relationship between two nations

Question 78

Christine works as a receptionist in an office.While at work,she is not supposed to access social networking Web sites.However,as her browsing activities are not monitored,she often uses the office network to access these Web sites.This is an example of ________.

A) adverse selection
B) moral hazard
C) a positive externality
D) the free-rider problem

Question 79

Governments are often forced to bail out large banks to prevent entire economies from being affected adversely.This provision often encourages banks to invest in risky assets.This is an example of ________.

A) moral hazard
B) a positive externality
C) adverse selection
D) anchoring

Question 80

Used cars in Corinthia sold for about 20 percent less than new cars of the same model manufactured in the same year.However,price differences were reduced when certified used car dealers entered the market for used cars in Corinthia.What explains this phenomenon?