Deck 23: Moral Hazard and Adverse Selection: Informational Market Failures

Question 1

You are approved for an insurance policy that protects your truck. The next day you become a reckless driver. This is an example of

A) illogical behavior
B) social welfare
C) moral hazard

Answer 1

moral hazard

Question 2

Assume that an insurance company lacks information about which potential customers fall into the safe group and which fall into the risky group. When an individual wants to purchase insurance, the company will assume that the potential customer is the

A) riskiest person
B) average person
C) safest person

Answer 2

average person

Question 3

If insurance companies cannot distinguish between the safe people and the risky people in a population because of a lack of information, the companies must charge everyone the same average premium.

Answer 3

True

Question 4

When the buyers and sellers in a market have different amounts of information, there exists asymmetric information.

Question 5

Because of a moral hazard problem, a market will

A) succeed
B) fail
C) reach equilibrium

Question 6

An insurance lacks the information needed to distinguish between safe and risky people and therefore charges everyone the same average premium. As a result, the ________ people will not buy insurance, and the industry will be selling only to ________ people.

A) risk-neutral, safe
B) safe, risky
C) risky, safe

Question 7

Free-market advocates would never suggest using signaling to solve problems of adverse selection.

Question 8

When an insurance company cannot observe the characteristics of potential clients and offers a contract that is accepted by bad risks, the company suffers from

A) adverse selection
B) moral hazard
C) pooling equilibrium

Question 9

Compared to safe people, risky people are __________ willing to buy insurance.

A) equally
B) more
C) less

Question 10

An equilibrium to a game of incomplete information where players of different types take identical actions so that others are not able to learn their types from observing the actions they take is called a pooling equilibrium.

Question 11

Co-insurance is an example of how a market failure due to moral hazard can be solved __________ government intervention.

A) with
B) partially by
C) without

Question 12

A separating equilibrium is an equilibrium where different types play differently so their types can be inferred by their actions.

Question 13

There could be a car repair equilibrium in which all experts are both competent and honest.

Question 14

An insurance company ______________________ whether its potential clients are safe or risky.

A) always knows
B) never knows
C) may or may not know

Question 15

A restaurant pays each waiter a salary and allows no tipping. The opportunity wage of good waiters (wg) is greater than the opportunity wage of bad waiters (wb). If the restaurant sets its salary between wb and wg , then it will attract only bad waiters.

Question 16

A lack of information about the riskiness of potential customers forces insurance companies to sell insurance on the assumption that they will face the average number of accidents for the population.

Question 17

The amount any agent will have to pay in the event that the situation being covered by the insurance company occurs is called the co-insurance (deductible).

Question 18

If an insurance company must charge all customers a uniform rate that reflects the average cost of insuring any individual in the population, this average cost will be too _______ to attract _______ risks but too _______ to fully cover the losses produced by the _______ risks.

A) high, bad, low, good
B) high, good, low, bad
C) low, good, high, bad

Question 19

If an insurance company selects its risks from the population in an adverse way, the company will probably

A) earn extra-normal profits
B) suffer severe losses
C) barely break even

Question 20

Adverse selection occurs in situations where one economic agent can observe the characteristics of another.

Question 21

Car owners will continue to seek information about possible repairs until the marginal cost of obtaining one more opinion _________________ the expected marginal benefit from the information contained in that opinion.

A) equals
B) is greater than
C) is less than

Question 22

Market signaling does not produce

A) Pareto-optimal results
B) separating equilibria
C) market solutions to adverse selection

Question 23

In a pooling equilibrium in which all potential customers attend safety school, the insurance company will charge

A) the same price for everyone
B) a higher price for risky people
C) a higher price for safe people

Question 24

Explain why we cannot trust that all car repair experts are both competent and honest.

Question 25

A restaurant pays each waiter a salary and allows no tipping. The opportunity wage of good waiters (wg) is greater than the opportunity wage of bad waiters (wb). If the restaurant sets its salary equal to or greater than wg, it will attract

A) both good and bad waiters
B) only good waiters
C) only bad waiters

Question 26

The car repair market can always have an equilibrium in which all experts are

A) honest
B) dishonest
C) credible

Question 27

The existence of a separating equilibrium depends upon differences in

A) opportunity cost
B) sunk cost
C) marginal cost

Question 28

An example of market signaling in the auto insurance market is

A) paying a higher deductible on comprehensive coverage
B) qualifying for a good student discount
C) Both answers are correct

Question 29

What are the pros and cons of market signaling?

Question 30

If the opportunity cost of sending a market signal if too great for risky people and low enough for safe people, there will exist a(n)

A) pooling equilibrium
B) separating equilibrium
C) adverse equilibrium

Question 31

If employers cannot distinguish between good and bad workers, then the employers must offer all workers a wage that reflects the __________ productivity of all workers in the population.

A) total
B) average
C) marginal

Question 32

Asymmetric information causes _______________ for car repair experts.

A) Nash equilibrium
B) moral hazard
C) adverse selection

Question 33

By allowing tipping, a restaurant can solve adverse selection in employing waiters by creating a

A) separating equilibrium
B) symmetric equilibrium
C) pooling equilibrium

Question 34

A market solution to adverse selection is

A) market signaling
B) insurance deductibles
C) co-insurance

Question 35

Does market failure due to moral hazard in the insurance industry mean that government must intervene?

Question 36

Tipping is a(n) ____________ solution.

A) nonmarket
B) immoral hazard
C) market

Question 37

Explain why insurance markets fail.

Question 38

If a reputation for bad service would ruin a restaurant, the owner of the restaurant cannot afford to hire

A) good workers
B) bad workers
C) any workers

Question 39

Compare and contrast adverse selection in the insurance industry and in employment decisions.

Question 40

A restaurant pays each waiter a salary and allows no tipping. The opportunity wage of good waiters (wg) is greater than the opportunity wage of bad waiters (wb). If the restaurant sets its salary below wb, it will attract

A) no waiters at all
B) only good waiters
C) only bad waiters