Deck 12: The Economics of Information

Question 1

You are a hotel manager and you are considering four projects that yield different payoffs, depending upon whether there is an economic boom or a recession. The potential payoffs and corresponding payoffs are summarized in the following table. Which project has the lowest variance?

A) A
B) B
C) C
D) D

Answer 1

D

Question 2

Joe's search costs are $5 per search. He wants to buy a video player for his wife for Christmas, and the lowest price he's found so far is $300. Joe thinks 80 percent of the stores charge $300 for video players and 20 percent charge $200. Joe's optimal decision is to:

A) continue to search for a lower price since the expected benefit of an additional search is $20, which exceeds his per-unit search costs.
B) stop searching and purchase a video player for $200.
C) continue to search for a lower price since the expected benefit of an additional search is $80, which exceeds his per-unit search costs.
D) None of the statements is correct.

Answer 2

A

Question 3

Suppose a risk-neutral competitive firm must set output before it knows for sure the market price. Suppose the market price is given by p = p* + e, where p* is the mean price and e is a random term with an expected value of zero. Then in order to maximize expected profits, the firm should produce where:

A) p = MC.
B) p* = MC.
C) p* + e = MC.
D) p > MC.

Answer 3

B

Question 4

Joe's search costs are $5 per search. He wants to buy a video player for his wife for Christmas, and the lowest price he's found so far is $200. Joe thinks 50 percent of the stores charge $200 for video players and 50 percent charge $190. Based on this information:

A) Joe should search again.
B) Joe should stop searching and purchase the video player at $200.
C) Joe is indifferent between searching again and stopping.
D) There is insufficient information to make a determination.

Question 5

You are a hotel manager and you are considering four projects that yield different payoffs, depending upon whether there is an economic boom or a recession. The potential payoffs and corresponding payoffs are summarized in the following table. The expected value of project C is:

A) $5.
B) $10.
C) $20.
D) None of the answers are correct.

Question 6

You are a hotel manager and you are considering four projects that yield different payoffs, depending upon whether there is an economic boom or a recession. The potential payoffs and corresponding payoffs are summarized in the following table. The expected value of project A is:

A) $5.
B) $10.
C) $20.
D) None of the statements is correct.

Question 7

Tim is offered two gambles. With gamble A, he either gains $2 or loses $1 with a 50 percent probability. With gamble B, he either gains $3 or loses $2 with a 50 percent probability. Tim prefers gamble B to gamble
A) Tim is risk loving.

A) What can we conclude?
B) Tim is risk neutral.
C) Tim is risk averse.
D) Insufficient information to determine.

Question 8

You are a hotel manager and you are considering four projects that yield different payoffs, depending upon whether there is an economic boom or a recession. The potential payoffs and corresponding payoffs are summarized in the following table. Which project has the lowest expected value?

A) A
B) B
C) C
D) D

Question 9

In the presence of ______, the market mechanism can break down.

A) extensive form games
B) normal form games
C) common knowledge
D) asymmetric information

Question 10

You are a hotel manager and you are considering four projects that yield different payoffs, depending upon whether there is an economic boom or a recession. The potential payoffs and corresponding payoffs are summarized in the following table. The expected value of project B is:

A) $5.
B) $10.
C) $20.
D) None of the answers are correct.

Question 11

_______ occurs when people smoke more after buying life insurance.

A) Adverse selection
B) Moral hazard
C) Asymmetric information
D) Cournot and Bertrand competition

Question 12

Risk-averse persons sometimes prefer to play some gambles even if they know that those gambles are not fair, i.e., on average people lose by playing them. One plausible explanation for this seemingly paradoxical phenomenon is that:

A) The economic theory of uncertainty is not correct.
B) Gambling has entertaining effects which are not treated explicitly as part of the payoffs.
C) People's actions are not reasonable.
D) None of the statements is correct.

Question 13

Suppose a risk-neutral competitive firm must produce output before the market price is known. If the uncertain price is given by p = p* + e, where e is a random term with an expected value of zero, a competitive firm should shut down in the short run if:

A) p* < AVC.
B) p* + e < AFC.
C) p* < AFC.
D) p* < MC.

Question 14

To maximize profit in the face of uncertainty, firms should produce the output where:

A) expected price equals expected marginal cost.
B) expected marginal revenue equals marginal cost.
C) expected marginal revenue equals expected marginal cost.
D) expected price equals marginal cost.

Question 15

You are a hotel manager and you are considering four projects that yield different payoffs, depending upon whether there is an economic boom or a recession. The potential payoffs and corresponding payoffs are summarized in the following table. Which project has the greatest expected value?

A) A
B) B
C) C
D) D

Question 16

Jane wants to buy a beautiful doll as a gift for her sister's birthday. She knows that the same product is offered in different shops with prices of $120, $100, and $80 with odds of one-third of finding each price. She just stopped at a shop and knows that the price is $100. Suppose that there is a search cost of $5 for each search. Should she search one more time?

A) Yes
B) No
C) She should toss a coin.
D) Insufficient information to determine.

Question 17

Which of the following phenomena shows that risk aversion is the characteristic of many people?

A) Gambling
B) Looting
C) Investing in one stock rather than a portfolio
D) Auto insurance

Question 18

You are a hotel manager and you are considering four projects that yield different payoffs, depending upon whether there is an economic boom or a recession. The potential payoffs and corresponding payoffs are summarized in the following table. The expected value of project D is:

A) $5.
B) $10.
C) $20.
D) None of the answers are correct.

Question 19

You are a hotel manager and you are considering four projects that yield different payoffs, depending upon whether there is an economic boom or a recession. The potential payoffs and corresponding payoffs are summarized in the following table. Which project yields the greatest return, regardless of whether a boom or a recession occurs?

A) A
B) B
C) C
D) D

Question 20

You are a hotel manager and you are considering four projects that yield different payoffs, depending upon whether there is an economic boom or a recession. The potential payoffs and
Corresponding payoffs are summarized in the following table. Which project has the greatest variance?

A) A
B) B
C) C
D) D

Question 21

After a person buys insurance for his car, he will generally not care for his car as much as he otherwise would. This is an example of:

A) adverse selection.
B) moral hazard.
C) risk aversion.
D) None of the statements is correct.

Question 22

Suppose that there are two types of cars, good and bad. The qualities of cars are not observable but are known to the sellers. Risk-neutral buyers and sellers have their own valuation of these two types of cars as follows: When a buyer does not observe the quality, what is the highest price she will offer for a used car if she ignores adverse selection?

A) $2,500
B) $3,000
C) $4,000
D) $4,500

Question 23

Jane wants to buy a beautiful doll as a gift for her sister's birthday. She knows that the same product is offered in different shops with prices of $120, $100, and $80 with odds of one-third of finding each price. She just stopped at a shop and knows that the price is $100. If the search cost is $8 per time, what should she do?

A) Search once more and decide again upon knowing the price.
B) Accept the offer in hand.
C) She should toss a coin.
D) Insufficient information to determine.

Question 24

Which of the following auction examples has a common value information structure?

A) Three firms bid for an oil lease.
B) An auction of a famous painting.
C) A college in need of money decides to name a building on campus after the person willing to pay the most for the privilege.
D) An auction of a famous painting and a college in need of money decides to name a building on campus after the person willing to pay the most for the privilege.

Question 25

Suppose that there are two types of cars, good and bad. The qualities of cars are not observable but are known to the sellers. Risk-neutral buyers and sellers have their own valuation of these two types of cars as follows: When buyers do not observe the quality, what happens in the market?

A) Both good and bad cars are traded.
B) Only good cars are traded.
C) Only bad cars are traded.
D) Neither good nor bad cars are traded.

Question 26

The optimal bid in a first-price, sealed-bid auction with independent private values is to bid:

A) the true value of the item.
B) more than the true value of the item.
C) less than the true value of the item.
D) the true value of the item and more than the true value of the item, depending upon whether value estimates are affiliated.

Question 27

Which of the following statements is NOT correct?

A) Information plays an important role in the economy.
B) Asymmetric information may lead to the disappearance of a market.
C) It is always desirable to have more information than the person one is trading with.
D) Adverse selection will not occur if there is no asymmetric information.

Question 28

Which of the following is a means of eliminating the undesirable effects of adverse selection?

A) A long-term relationship
B) Writing a contract to guarantee the quality
C) Both a long-term relationship and writing a contract to guarantee the quality
D) None of the statements is correct.

Question 29

An apple farmer must decide how many apples to harvest for the world apple market. He knows that there is a one-third probability that the world price will be $1, a one-third probability that it will be $1.50, and a one-third probability that it will be $2. His cost function is C(Q) = 0.01Q². What is the expected price in the world apple market?

A) $1.50
B) $1.80
C) $2.00
D) $1.40

Question 30

Which of the following is a feature of a Dutch auction?

A) The auctioneer begins with a very high asking price.
B) The winner pays the second-highest bidder's valuation.
C) Bidders write their valuation in a paper simultaneously and separately.
D) More than one bidder will announce their valuation.

Question 31

An incumbent usually charges a higher price than a new entrant does. Which of the following is a plausible reason for this observation?

A) An incumbent usually has a bigger bureaucratic body than a new entrant does and hence has a higher marginal cost.
B) Consumers are risk averse, hence new firms charge lower prices to attract customers.
C) The incumbent is ignorant of the new entrant, hence it is still charging the old high price.
D) All of the statements associated with this question are correct.

Question 32

When each bidder in an auction knows what the item is worth to that bidder, but does not know the valuations of other bidders, the auction exhibits:

A) perfect information.
B) common values.
C) private values.
D) partially private values.

Question 33

An apple farmer must decide how many apples to harvest for the world apple market. He knows that there is a one-third probability that the world price will be $1, a one-third probability that it will be $1.50, and a one-third probability that it will be $2. His cost function is C(Q) = 0.01Q². The farmer's maximum expected profit is:

A) -$7.75.
B) $0.
C) $7.75.
D) None of the answers are correct.

Question 34

An apple farmer must decide how many apples to harvest for the world apple market. He knows that there is a one-third probability that the world price will be $1, a one-third probability that it will be $1.50, and a one-third probability that it will be $2. His cost function is C(Q) = .01Q². If the farmer is risk neutral:

A) he strictly prefers producing the expected profit-maximizing quantity to producing nothing.
B) he is indifferent between producing the expected profit-maximizing quantity and producing nothing.
C) he should produce at a quantity in between zero and the expected profit-maximizing quantity.
D) he strictly prefers to produce.

Question 35

People with a bad driving record find it difficult to buy automobile insurance because insurance companies fear that ___________ may happen if they raise the premiums.

A) adverse selection
B) moral hazard
C) risk aversion
D) none of the statements associated with this question are correct

Question 36

Which of the following types of auctions was NOT described in the text?

A) English auction
B) Second-price sealed bid auction
C) Third-price sealed bid auction
D) Dutch auction

Question 37

Suppose that there are two types of cars, good and bad. The qualities of cars are not observable but are known to the sellers. Risk-neutral buyers and sellers have their own valuation of these two types of cars as follows: Now suppose that sellers value a good car at $4,500 and a bad car at $2,500, and quality is not observed by the buyers. What is the highest price that risk-neutral buyers will offer for a used car if they recognize adverse selection?

A) $2,500
B) $3,000
C) $4,000
D) $4,500

Question 38

Which of the following statements is NOT true?

A) The Dutch and first-price, sealed-bid auctions are strategically equivalent.
B) A mineral rights auction is a common value auction.
C) An auctioneer is always indifferent between different kinds of auctions.
D) An English auction yields higher expected revenues than a second-price, sealed-bid auction when bidders are risk averse.

Question 39

Suppose that there are two types of cars, good and bad. The qualities of cars are not observable but are known to the sellers. Risk-neutral buyers and sellers have their own valuation of these two types of cars as follows: Suppose that both buyers and sellers observe the quality. What happens?

A) Both good and bad cars are traded.
B) Only good cars are traded.
C) Only bad cars are traded.
D) Neither good nor bad cars are traded.

Question 40

Which of the following is a possible critique of the decision theory under uncertainty presented in the text?

A) People do not always know the "true" probability of complicated events.
B) Decision theory assumes that people are good at math.
C) Decision theory assumes that people face the same situation (uncertainty) repeatedly.
D) People are not risk averse.

Question 41

Consumers spend a lot more time searching for good bargains during recessions because:

A) goods are more expensive during recessions and hence expected benefits of a search are higher.
B) in recessions, many individuals are out of work, which lowers their opportunity cost of time.
C) goods are more expensive during recessions and hence expected benefits of a search are higher and in recessions, many individuals are out of work, which lowers their opportunity cost of time.
D) None of the statements is correct.

Question 42

Consider an antique auction where bidders have independent private values. There are two bidders, each of whom perceives that valuations are uniformly distributed between $100 and $1,000. One of the bidders is Sue, who knows her own valuation is $200. What is Sue's optimal bidding strategy in a second-price, sealed-bid auction?

A) Submit a bid of $150.
B) Submit a bid of $200.
C) Submit a bid that is less than $150.
D) Yell "mine" when the bid reaches $150.

Question 43

To avoid the winner's curse, a bidder should:

A) not participate in Dutch auctions.
B) only participate in second-price and English auctions.
C) revise upward his private estimate of the value of the item.
D) revise downward his private estimate of the value of the item.

Question 44

Your firm is planning to hold an auction to sell its oil field. What type of auction should you suggest to your boss?

A) Dutch auction
B) English auction
C) Second-price, sealed-bid auction
D) None of the statements is correct.

Question 45

If insurance companies are required to offer coverage to all interested people, it is said that premiums for each person will be increased. Assume that the insurance market is perfectly competitive. What is the major reason for raising the premium?

A) The insurance companies take advantage of the increased demand and collude.
B) Medical services are more expensive because of increased demand.
C) Less healthy people join the pool of insured and hence increase the risk and the premium.
D) None of the statements is correct.

Question 46

A risk-neutral monopoly must set output before it knows the market price. There is a 50 percent chance the firm's demand curve will be P = 20 - Q and a 50 percent chance it will be P = 40 - Q. The marginal cost of the firm is MC = Q. The profits are maximized in the expected sense when:

A) Expected value of price = E(MR).
B) MC = Expected value of price.
C) MC < E(MR).
D) MC = E(MR).

Question 47

The winner's curse occurs:

A) only in English auctions.
B) only in second-price, sealed-bid auctions.
C) in a common-values auction.
D) in a private-values auction.

Question 48

Consider an antique auction where bidders have independent private values. There are two bidders, each of whom perceives that valuations are uniformly distributed between $100 and $1,000. One of the bidders is Sue, who knows her own valuation is $200. What is Sue's optimal bidding strategy in a Dutch auction?

A) Submit a bid of $150.
B) Submit a bid of $200.
C) Submit a bid that is less than $150.
D) Yell "mine" when the bid reaches $150.

Question 49

A consumer spends more time searching for a good when her reservation price is:

A) increased.
B) reduced.
C) fixed.
D) None of the statements is correct.

Question 50

A risk-neutral monopoly must set output before it knows the market price. There is a 50 percent chance the firm's demand curve will be P = 20 - Q and a 50 percent chance it will be P = 40 - Q. The marginal cost of the firm is MC = Q. What is the expression for the expected marginal revenue function?

A) E(MR) = 20 - 2Q
B) E(MR) = 30 - 2Q
C) E(MR) = 40 - 2Q
D) E(MR) = 50 - 2Q

Question 51

John is a seller in an independent private-values auction environment where bidders are risk neutral. Which auction yields John the greatest expected revenue?

A) English
B) First price
C) Second price
D) All of the choices are revenue equivalent.

Question 52

Holding the mean constant, the larger the standard deviation, the ____________ the gamble will be.

A) more risky
B) less risky
C) higher utility
D) None of the statements is correct.

Question 53

In order to reduce the undesirable effects of moral hazard, an insurance company can:

A) introduce a deductible.
B) classify clients into different types according to their history.
C) reject the renewal of policies of those people with really bad records.
D) All of the statements associated with this question are correct.

Question 54

Consider an antique auction where bidders have independent private values. There are two bidders, each of whom perceives that valuations are uniformly distributed between $100 and $1,000. One of the bidders is Sue, who knows her own valuation is $200. What is Sue's optimal bidding strategy in an English auction?

A) Submit a bid of $150.
B) Submit a bid of $200.
C) Submit a bid that is less than $150.
D) Keep bidding until the bid exceeds $200.

Question 55

The optimal strategy for a risk-neutral bidder in a second-price, sealed-bid auction with independent private values is to bid:

A) slightly less than his or her valuation.
B) slightly higher than his or her valuation.
C) his or her true valuation.
D) None of the statements is correct.

Question 56

You are a hotel manager considering four projects that yield different payoffs, depending upon whether there is an economic boom or a recession. The potential payoffs and corresponding payoffs are summarized in the following table. The expected value of project A is:

A) $5.
B) $10.
C) $20.
D) None of the answers are correct.

Question 57

John is a seller in an affiliated-values auction environment where bidders are risk neutral. Which auction yields John the greatest expected revenue?

A) English
B) First price
C) Second price
D) All of the choices are revenue equivalent.

Question 58

You are a hotel manager considering four projects that yield different payoffs, depending upon whether there is an economic boom or a recession. The potential payoffs and corresponding payoffs are summarized in the following table. Which project has the highest variance?

A) A
B) B
C) C
D) D

Question 59

A risk-neutral monopoly must set output before it knows the market price. There is a 50 percent chance the firm's demand curve will be P = 20 - Q and a 50 percent chance it will be P = 40 - Q. The marginal cost of the firm is MC = Q. The expected profit-maximizing price is:

A) $5.
B) $10.
C) $15.
D) $20.

Question 60

Consider an antique auction where bidders have independent private values. There are two bidders, each of whom perceives that valuations are uniformly distributed between $100 and $1,000. One of the bidders is Sue, who knows her own valuation is $200. What is Sue's optimal bidding strategy in a first-price, sealed-bid auction?

A) Submit a bid of $150.
B) Submit a bid of $200.
C) Submit a bid that is less than $150.
D) Yell "mine" when the bid reaches $150.

Question 61

Which of the following is NOT an example of a managerial decision with risk-averse consumers?

A) The presence of insurance for certain events
B) The existence of chain stores
C) The existence of different product qualities
D) All of the statements associated with this question illustrate examples of managerial decisions with risk-averse consumers.

Question 62

A consumer spends less time searching for a good when her reservation price is:

A) increased.
B) reduced.
C) fixed.
D) None of the answers are correct.

Question 63

Suppose you are a risk-neutral manager attempting to hire a new sales manager. All of the workers in the market have the same ability to manage and sell, but they differ with respect to the wage at which they are willing to work for your company. The market for sales managers is composed of three types of individuals: 85 percent are willing to work for $75,000 and 15 percent are willing to work for $85,000. The first interviewee is only willing to work for $85,000. If the human resource director spends five hours interviewing each candidate and the opportunity cost of this director's time is $500, then the director should:

A) search again since the expected benefit of an additional search exceeds the cost.
B) stop searching since the expected benefit of an additional search is less than the cost.
C) search again since the expected benefit of an additional search is less than the cost.
D) stop searching since the expected benefit of an additional search exceeds the cost.

Question 64

Suppose a consumer has determined that her reservation price, R, is $75. The expected benefit of an additional search at this reservation price is $25. Based on this information we can conclude that:

A) search costs are $25 per search.
B) this consumer will reject any price above $25.
C) this consumer will accept any price below $75.
D) search costs are $25 per search, and this consumer will accept any price below $75.

Question 65

A risk-neutral monopoly must set output before it knows the market price. There is a 50 percent chance the firm's demand curve will be P = 40 - Q and a 50 percent chance it will be P = 60 - Q. The marginal cost of the firm is MC = 3Q. The expected profit-maximizing price is:

A) $10.
B) $20.
C) $30.
D) $40.

Question 66

The optimal bid for an individual participating in a first-price, sealed-bid auction with independent private values is to bid:

A) more than the individual's valuation of the item.
B) less than the individual's valuation of the item.
C) exactly the individual's valuation of the item.
D) There is not an optimal bid strategy for all individuals when independent private values exist.

Question 67

Holding the mean value of a gamble constant, the larger the standard deviation, the:

A) higher the utility will be from the gamble.
B) less risky the gamble will be.
C) more risky the gamble will be.
D) None of the answers are correct.

Question 68

Suppose that 90 percent of the firms selling good X charge the low price. If the remaining 10 percent of firms charge $50 per unit and the expected benefit of an additional search is $10, then the lowest price in the market for good X is:

A) $45.
B) $38.89.
C) $10.
D) $0.

Question 69

Many tout that the Internet has lowered consumers' search costs. If this is true, ceteris parabis, the consumer reservation price should:

A) be higher.
B) be lower.
C) remain the same.
D) There is insufficient information to determine the impact of lower search costs on reservation prices.

Question 70

The St. Petersburg paradox occurs when:

A) individuals are willing to pay significantly less than the expected value of a gamble.
B) individuals are willing to pay exactly the expected value of a gamble.
C) individuals are willing to pay significantly more than the expected value of a gamble.
D) None of the statements illustrates the St. Petersburg paradox.

Question 71

Which of the following is a feature of a Dutch auction?

A) The auctioneer begins with a very low asking price.
B) The winner pays exactly what she bid for the item.
C) Bidders simultaneously write their valuations on paper and submit them independently.
D) Several bidders will announce their valuations.

Question 72

You are a hotel manager considering four projects that yield different payoffs, depending upon whether there is an economic boom or a recession. The potential payoffs and corresponding payoffs are summarized in the following table. If a manager adopted both project A and project B simultaneously, the expected value of this joint project would be:

A) $20.
B) $30.
C) $40.
D) None of the statements are correct.

Question 73

Which of the following statements is NOT correct about information?

A) It is always desirable for some people to have more information than others.
B) Adverse selection will not occur if there is full information given to all market participants.
C) Information plays an important role in how the economy functions.
D) Asymmetric information may lead to the disappearance of a market.

Question 74

Which of the following phenomena shows that risk aversion is the characteristic of many people?

A) The popularity of high-stakes poker tournaments
B) Horse-race betting
C) Investing in one stock rather than a portfolio
D) Homeowners insurance

Question 75

Which of the following statements is true?

A) A mineral rights auction is not the same as a common-value auction.
B) An auctioneer is always indifferent between different kinds of auctions.
C) The Dutch and first-price, sealed-bid auctions are strategically equivalent.
D) An English auction always yields lower expected revenues than a second-price, sealed-bid auction.

Question 76

Suppose you are a risk-neutral manager attempting to hire a new sales manager. All of the workers in the market have the same ability to manage and sell, but they differ with respect to the wage at which they are willing to work for your company. The market for sales managers is composed of two types of individuals: 35 percent are willing to work for $50,000 and 65 percent are willing to work for $75,000. The first interviewee is only willing to work for $75,000. The expected benefit from an additional search is:

A) $32,500.
B) $26,250.
C) $16,250.
D) $8,750.

Question 77

A risk-neutral monopoly must set output before it knows the market price. There is a 50 percent chance the firm's demand curve will be P = 40 - Q and a 50 percent chance it will be P = 60 - Q. The marginal cost of the firm is MC = 3Q. What is the expression for the expected marginal revenue function?

A) E(MR) = 30 - 2Q
B) E(MR) = 40 - 2Q
C) E(MR) = 50 - 2Q
D) E(MR) = 60 - 2Q

Question 78

When managers of firms are given fixed salaries, which are not tied to the firm's profits, they generally put forth less effort than they otherwise would. This is an example of:

A) adverse selection.
B) moral hazard.
C) risk aversion.
D) None of the answers are correct.

Question 79

Consider a market for product X where 75 percent of the stores charge $500 and 25 percent charge $450. Compute the expected benefit from an additional search when the first search results in a price of $500.

A) $37.50
B) $50
C) $12.50
D) $500

Question 80

Consider a game that pays 2ⁿ cents if the first tail is on the n^th toss of a fair-headed coin. Determine the expected value of this game.

A) 1 cent
B) $2
C) Infinite cents
D) There is insufficient information to determine the expected value of this gamble.