Deck 14: Imperfect Information: Adverse Selection and Moral Hazard

Question 1

The domination of the used car market by lemons is an example of the ________ problem.

A) adverse selection
B) moral hazard
C) perfect information
D) marginal analysis

Answer 1

adverse selection

Question 2

Table 14.1
Refer to Table 14.1,which shows the market for used motorcycles in a small Midwestern town.As buyers adjust their expectations of lemons in this market,

A) the price they will be willing to pay will rise.
B) the quantity of plums supplied will rise.
C) the proportion of lemons in the market will rise.
D) all of the above

Answer 2

the proportion of lemons in the market will rise.

Question 3

An example of adverse selection is

A) when high-quality loan applicants drive low-quality loan applicants out of the market for bank loans.
B) when a person discovers that he has a serious illness and then purchases health insurance.
C) when consumers are not willing to pay top dollar for a used car because of imperfect information.
D) All of the above are examples of adverse selection.

Answer 3

when consumers are not willing to pay top dollar for a used car because of imperfect information.

Question 4

Table 14.2
Refer to table 14.2.The buyers assumed chance of getting a lemon will ________ and hence the willingness to pay for the used boat will ________.

A) fall; rise
B) rise; fall
C) fall; fall
D) rise; rise

Question 5

You want to purchase a new car.You have gone to 3 dealerships that sell the type of car you want.The price of the car is different at each of the dealerships.You have estimated that if you go to another dealership,the marginal amount you may save will be $250,but the marginal cost of going to the dealership would be $350.Which of the following statements is accurate?

A) You should go to the next dealership, as you would be able to save an additional $250.
B) In order to determine whether or not you should go to the next dealership, you would need to know the total costs and total benefits of this action.
C) You should not go to the next dealership because the marginal cost of this action exceeds the marginal benefit.
D) You should continue going to dealerships as long as the marginal benefit of additional search is positive.

Question 6

Dan is trying to sell a high-quality used desktop computer,but all potential buyers are not willing to pay the price that Dan wants.This is likely due to a(n)________ problem.

A) moral hazard
B) disutility
C) adverse selection
D) price discrimination

Question 7

A situation in which the uninformed side of the market must choose from an undesirable selection of goods is an example of

A) indifferent information.
B) perfect information.
C) asymmetric information.
D) a thick market.

Question 8

Suppose that buyers in the used electric washer market are willing to pay $100 for a high-quality electric washer and $50 for a low-quality electric washer.If buyers believe that 70% of all used electric washer are low-quality,what is the maximum price they would be willing to pay for a used electric washer?

A) $35
B) $50
C) $65
D) $70

Question 9

Table 14.1
Refer to Table 14.1,which shows the market for used motorcycles in a small Midwestern town.Which of the following is true?

A) The market is in equilibrium.
B) We can expect the price of used motorcycles to fall.
C) We can expect the price of used motorcycles to rise.
D) Buyers' willingness to pay for a used motorcycle will remain unchanged.

Question 10

In the market for automobile insurance,asymmetric information occurs when

A) insured drivers drive more safely than uninsured drivers.
B) insured drivers drive more recklessly than uninsured drivers.
C) drivers with greater risk purchase more automobile insurance.
D) automobile insurance is universal.

Question 11

The lemons problem may cause markets with asymmetric information

A) to reduce the number of low-quality goods.
B) to reduce the number of high-quality goods.
C) to increase the number of high-quality goods.
D) to increase the average quality of goods.

Question 12

Table 14.2
Refer to Table 14.2,which shows the market for used fishing boats.Which of the following is NOT true about this market?

A) The price buyers will be willing to pay will rise.
B) The quantity of plums supplied will rise.
C) The proportion of lemons in the market will rise.
D) All of the above are false.

Question 13

Table 14.2
Refer to Table 14.2,which shows the market for used fishing boats.Which of the following is true about this market?

A) The market is in equilibrium.
B) We can expect the price of used boats to fall.
C) We can expect the price of used boats to rise.
D) Buyers' willingness to pay for a used boat will fall.

Question 14

Because of asymmetric information,a seller of a lemon used car earns

A) more profit than a seller of a plum used car.
B) less profit than a seller of a plum used car.
C) the same profit as a seller of a plum used car.
D) less revenue than a seller of a plum used car.

Question 15

Suppose that buyers in the used refrigerator market are willing to pay $500 for a high-quality refrigerators and $200 for a low-quality refrigerators.If buyers believe that 50% of all used refrigerators are low-quality,what is the maximum price they would be willing to pay for a used refrigerator?

A) $200
B) $340
C) $350
D) $500

Question 16

On an automobile insurance policy,a deductible is the dollar amount that the driver will pay toward damages before the insurance company will pay anything.Asymmetric information suggests that

A) high-risk drivers will buy a policy without any deductible.
B) high-risk drivers will buy a policy with a very high deductible.
C) insured drivers drive more safely than uninsured drivers.
D) insured drivers drive more recklessly than uninsured drivers.

Question 17

In the market for used boats there are high-quality boats and poor-quality boats.Potential buyers cannot determine prior to purchase whether the boat is high quality or low quality.Which of the following statements best describes what is likely to happen in this market?

A) The price of a used boat will be very close to the value of a high-quality motorcycle, which will encourage people to sell high-quality boats.
B) The price of a used boat will be between the value of a high-quality and low-quality boat. This will encourage people to withdraw high-quality boats from the market.
C) The price of a used boat will be very close to the value of a low-quality boat, since the buyer will not be willing to pay any more than this price given the uncertainly of what they will get.
D) No used boats will be bought or sold given the uncertainty faced by the buyer.

Question 18

The result of adverse selection is that

A) higher-quality producers drive lower-quality producers out of the market.
B) lower-quality producers drive higher-quality producers out of the market.
C) consumers will be able to purchase only high-quality products.
D) higher-quality producers receive a higher price than they would if adverse selection was not present.

Question 19

If one side of the market,either the buyer or seller of a good or service,has better information than the other side,there is

A) moral hazard.
B) asymmetric information.
C) an external cost.
D) a free-rider problem.

Question 20

Adverse selection describes the situation that occurs when

A) people have perfect information.
B) high-quality products are driven from the market by low-quality products due to imperfect information.
C) actions that were expected to happen do not occur.
D) low-quality products are driven from the market by high-quality products because of imperfect information.

Question 21

Explain the two predictions made by the lemons model.

Question 22

A mixed market exists when goods of different qualities are sold for the same price.

Question 23

The adverse selection problem happens when an informed buyer or seller must choose from an undesirable selection of goods.

Question 24

Martha is trying to sell a high-quality television.All of the potential buyers are not willing to pay the price that Martha deserves.Explain to Martha how the problem of asymmetric information has led to this situation.

Question 25

In an asymmetric market for used cars,which of the following could be used to avoid a thin market?

A) offering money-back guarantees on plum used cars
B) offering warranties on lemon used cars
C) offering repair guarantees on lemon used cars
D) used car salesmen

Question 26

Various state governments have passed "lemon laws" to protect buyers of used cars as a result of the problem of

A) moral hazard.
B) spillovers.
C) an injunction.
D) asymmetric information.

Question 27

The result of adverse selection is that the presence of high-quality goods in the market drive low-quality goods out of the market.

Question 28

What is a thin market?

Question 29

Asymmetric information occurs if John,who is buying Kim's used Toyota Corolla,has the same amount of information as Kim.

Question 30

Consider a market in which some high-quality goods are sold,but not as many as if there was perfect information about the quality of the good.This type of market is known as a(n)

A) beneficial selection.
B) thin market.
C) symmetric market.
D) efficient market.

Question 31

Symmetric information occurs when both buyers and sellers have imperfect information.

Question 32

Suppose that buyers are willing to pay $1,000 for a plum used computer and $300 for a lemon.If buyers expect 40% of the used computers to be plums,what is the maximum amount that buyers will be willing to pay for a used computer?

Question 33

What is adverse selection?

Question 34

Suppose that in a small town 40 used cars are sold each month.Of the 40 cars sold,30 are lemons and 10 are plums.If consumers expect 50% of the used cars sold to be lemons,this market is in equilibrium.

Question 35

Suppose that in a small town 40 used cars are sold each month.Of the 40 cars sold,30 are lemons and 10 are plums.If consumers expect 50% of the used cars sold to be lemons,we can expect the price that buyers are willing to pay to fall over time.

Question 36

Recall the Application about the free-agent market for professional baseball pitchers to answer the following question(s).
Recall the Application.Assume professional pitchers who are free agents and are more likely to get injured switch teams more often than those who are less likely to get injured.How is this situation explained by asymmetric information?

A) The coaches, physicians, and trainers from the player's original team have interacted with the player for years and know if player is likely to suffer from injuries. The new team has the same information because they can check the league records.
B) The coaches, physicians, and trainers from the player's original team have interacted with the player on a daily basis for years and know if player is likely to suffer from injuries. The new team has less information because they have not interacted with the player daily.
C) The coaches, physicians, and trainers from the player's new team have not interacted with the player on a daily basis for years and don't know if player is likely to suffer from injuries but have the league records that contain all the information that the new team needs to determine if the pitcher is a lemon or plum.
D) There is a perfect amount of information for the pitcher and the new team.

Question 37

Suppose that buyers are willing to pay $8,000 for a plum used car and $2,000 for a lemon.If buyers expect 70% of the used cars to be lemons,what is the maximum amount that buyers will be willing to pay for a used car?

Question 38

What is asymmetric information?

Question 39

Asymmetric information occurs

A) only in used good markets.
B) only in new good markets.
C) in the markets for new and used goods.
D) only in public good markets.

Question 40

Recall the Application about the free-agent market for professional baseball pitchers to answer the following question(s).
Recall the Application.In the market for used baseball pitchers,

A) free agency has eliminated the adverse selection problem.
B) pitchers who switch teams are generally healthier than those who do not.
C) asymmetric information leads to adverse selection.
D) both A and B

Question 41

In the market for insurance,sellers have

A) perfect information.
B) less information than buyers.
C) more information than buyers.
D) none of the above

Question 42

If insurance premiums are based on an experience rating,

A) every firm in a given area pays the same price for medical insurance.
B) insurance premiums are based on the past medical bills of a firm's employees.
C) firms have no incentive to try to lower the health care costs of their employees.
D) firms will not be concerned with the health problems of job applicants.

Question 43

How does the Internet auction site,eBay,address the asymmetric information problem?

Question 44

When the buyer is more knowledgeable than the seller,there is a(n)

A) moral hazard problem.
B) asymmetric information problem.
C) perfect information problem.
D) the lemon problem.

Question 45

Recall the Application about federal quality standards in the market for kiwifruit to answer the following question(s).
Recall the Application.If the problem of adverse selection exists in the kiwifruit market,we can expect the quality of fruit to be ________ and the price to be ________.

A) high; high
B) high; low
C) low; high
D) low; low

Question 46

Joe is in the market for a mattress.He is deciding between two different mattresses: one that is fairly expensive but offers a free 20-year manufacturer's warranty and another that is lower-priced but only offers a one-year manufacturer's warranty.Joe's decision to purchase the more expensive mattress would indicate that

A) Joe has a high level of income.
B) Joe is not price sensitive.
C) Joe interpreted the manufacturer's warranty as a quality indicator.
D) Joe is not a utility maximizer.

Question 47

Recall the Application about federal quality standards in the market for kiwifruit to answer the following question(s).
Recall the Application.There is asymmetric information in the kiwifruit market because

A) buyers have more information than sellers.
B) sellers have more information than buyers.
C) both the buyers and sellers have complete information.
D) sellers have the same information as the buyers.

Question 48

Refer to Figure 14.1.If the insurance company in this market becomes pessimistic and assumes that all buyers will be high-cost consumers,the equilibrium will be at

A) point a.
B) point b.
C) point c.
D) none of the above

Question 49

Adverse selection problem in the kiwifruit market leads to the presence of low-quality kiwifruit that will increase the number of high-quality kiwifruit.

Question 50

Refer to Figure 14.1.If the price of insurance is $5,000,then

A) 50% of the consumers will be high-cost.
B) 25% of the consumers will be low-cost.
C) 75% of the consumers will be low-cost.
D) 50% of the consumers will be low-cost.

Question 51

Refer to Figure 14.1.If the price of insurance is $7,500,then

A) 50% of the consumers will be high-cost.
B) 25% of the consumers will be low-cost.
C) 75% of the consumers will be high-cost.
D) 100% of the consumers will be high-cost.

Question 52

Which of the following is a way of responding to the lemons problem?

A) a money-back guarantee
B) a warranty
C) a repair guarantee
D) all of the above

Question 53

When considering the adverse-selection problem in the case of medical insurance,as the cost of insurance rises

A) healthy people might reduce their coverage while unhealthy people will maintain their coverage.
B) unhealthy people might reduce their coverage, while healthy people will maintain their coverage.
C) both healthy and unhealthy people will likely reduce their coverage.
D) both healthy and unhealthy people will likely maintain their coverage.

Question 54

Consumers can interpret the fact that a product offers a lifetime warranty as a sign that the product is of high quality.

Question 55

A product that offers a guarantee is not any more appealing to consumers than a similar product that does not offer a guarantee as long as the two products are priced the same.

Question 56

Car companies offer certified pre-owned vehicles to reduce the problem of moral hazard.

Question 57

One method of responding to the lemons effect is to invest in information.

Question 58

Refer to Figure 14.1.If the insurance company assumes there will be a 50-50 split between high-cost and low-cost customers,the price of insurance will be ________ and there will be ________ consumers.

A) 5,000; 150
B) 5,000; 200
C) 7,500; 75
D) 7,500; 125

Question 59

What can a seller do to try to distinguish his product as a high-quality product if consumers are skeptical?

Question 60

Lemons laws

A) protect producers from unsatisfied buyers.
B) require automakers to repurchase automobiles that experience frequent problems during their first year of use.
C) increase the quantity of lemons for sale on the used car market.
D) none of the above

Question 61

Health insurance companies are often at an advantage because they must pick from a desirable selection of customers.

Question 62

Which of the following is an example of moral hazard?

A) a person who drives more recklessly after obtaining automobile insurance
B) a person who engages in unrisky behavior after enrolling in his firm's health insurance plan
C) a driver who reduces his level of insurance coverage after his premiums rise
D) all of the above

Question 63

A firm's health insurance premiums that are based on an experience rating are affected by the amount of medical claims by the firm's employees.

Question 64

The health insurance premiums for Firm A's employees are based on an experience rating.Which of the following is correct?

A) Firm A will be more likely to screen job applicants for health problems in order to keep its premiums low.
B) Firm A will be more likely to offer safety and health programs for its employees.
C) Firm A will be less likely to consider the health of job applicants when hiring new employees.
D) Both A and B are correct.

Question 65

One implication of asymmetric information in the insurance market is that many low cost consumers who are not eligible for a group plan will carry individual insurance.

Question 66

An example of moral hazard is

A) a situation where high-quality loan applicants drive low-quality loan applicants out of the market for bank loans.
B) a situation where equally qualified men and women do not earn the same wages in the same occupation.
C) a situation where individuals are not willing to pay top dollar for a used car because they assume it is a lemon.
D) a situation where a person purchases life insurance and then lives recklessly.

Question 67

Recall the Application about genetic discrimination to answer the following question(s).
According to the Application,the information provided from genetic testing would increase insurance prices for ________ ,decrease insurance prices for ________,and therefore ________ the adverse selection problem.

A) high-cost customers; low-cost customers; increase
B) low-cost customers; high-cost customers; increase
C) low-cost customers; high-cost customers; decrease
D) high-cost customers; low-cost customers; decrease

Question 68

Would a firm whose health insurance premiums are based on an experience rating be more likely to develop health and safety educational programs for its employees? Explain why or why not.

Question 69

If a person drives less carefully after purchasing automobile insurance,

A) it is due to adverse selection.
B) moral hazard exists.
C) the person's insurance deductible must be large.
D) the insurance company must have perfect information.

Question 70

As more high-risk consumers enter the health insurance market,the average cost of health insurance service decreases.

Question 71

Explain why the insurance market suffers from the adverse-selection problem.

Question 72

Suppose air bags are installed on all cars sold.Which of the following is likely to occur?

A) There are fewer accidents because cars are safer.
B) People drive more carefully.
C) People drive more recklessly and there are more accidents.
D) People drive more recklessly and there are fewer accidents.

Question 73

After Johan purchased a full coverage insurance policy for his car,he is not careful and leaves his car unlocked at all times.This is an example of

A) adverse selection.
B) a thin market.
C) moral hazard.
D) asymmetric information.

Question 74

Moral hazard is the situation in which

A) a consumer buys a lemon.
B) one consumer pays a higher price than another consumer for the same product.
C) a consumer changes his behavior after purchasing insurance.
D) a consumer steals merchandise from a store.

Question 75

Recall the Application about genetic discrimination to answer the following question(s).
According to the Application,genetic discrimination occurs when an insurance company treats someone differently

A) because of gender-bias.
B) due to a gene mutation that increases the risk of an inherited disorder.
C) due to race and/or ethnicity.
D) based on religious preference.

Question 76

Suppose air bags make people feel safer and hence they drive more recklessly.This is an example of

A) moral hazard.
B) adverse selection.
C) asymmetric information.
D) a lemon market.

Question 77

A situation in which one side of an economic relationship takes undesirable or costly actions that the other side of the relationship cannot observe is called

A) adverse selection.
B) moral hazard.
C) thick markets.
D) an injunction.

Question 78

There is asymmetric information in the auto insurance market because companies know more about customers' driving habits and can predict very well the chances of customers getting into an accident than the customers.

Question 79

Most of the working-age people in the United States have private health insurance.

Question 80

Suppose more people drive SUVs because they believe they are safer than cars.The number of car-related deaths may increase if

A) an adverse selection problem causes people to drive more recklessly.
B) a moral hazard problem causes people to drive more recklessly.
C) there is adverse selection in the market for SUVs.
D) there is asymmetric information in the market for sedans.