Question 1

Adverse selection is a situation in which asymmetric information results in low-quality goods or low-quality consumers being squeezed out of transactions because they are unable to demonstrate their quality.

Accepted Answer

A) True 
 B)False

Question 2

Refer to the information provided in Figure 17.1 below to answer the questions that follow.  Figure 17.1
-Refer to Figure 17.1. Suppose John's utility from income is given in the figure. From this we would say that John is ________.

Accepted Answer

A)  risk neutral 
B)  risk averse 
C)  risk loving 
D)  a risk taker

Question 3

Mark has two job offers when he graduates from college. Mark views the offers as identical, except for the salary terms. The first offer is at a fixed annual salary of $40,000. The second offer is at a fixed salary of $20,000 plus a possible bonus of $40,000. Mark believes that he has a 50-50 chance of earning the bonus. If Mark takes the offer that maximizes his expected utility and is risk loving, which job offer will he choose?

Accepted Answer

A)  Mark will take the first offer. 
B)  Mark will take the second offer. 
C)  Mark is indifferent between the offers-both yield the same expected utility. 
D)  Indeterminate from the given information.

Question 4

A lender faces a(n) ________ problem when the lender lends funds to a borrower for a specific purpose and the borrower then opportunistically uses the funds for another purpose.

Accepted Answer

A)  adverse selection 
B)  moral hazard 
C)  external cost 
D)  free‐rider

Question 5

Refer to the data provided in Table 17.2 below to answer the following questions. The table shows the relationship between income and utility for Sue.
Table 17.2
 $$\begin{array} { | c | c | } 
\hline \text { Income } & \text { Total Utility } \
\hline \$ 0 & 0 \
\hline \$ 20,000 & 20 \
\hline \$ 40,000 & 40 \
\hline \$ 60,000 & 60 \
\hline \$ 80,000 & 80\
\hline
\end{array}$$
-Refer to Table 17.2. Sue earns $40,000 annually. She has the opportunity to bet her entire salary on the upcoming super bowl. If Sue takes the bet, she will pick the Patriots. She believes that the Patriots have a 50-50 chance of winning the game. If the Patriots win, Sue will win $81,000 but if they lose she loses her entire salary ($0). Will Sue take the bet?

Accepted Answer

A)  yes 
B)  no 
C)  maybe 
D)  indeterminate from the given information

Question 6

Refer to the data provided in Table 17.1 below to answer the following questions. The table shows the relationship between income and utility for Jane.
Table 17.1
 $$\begin{array} { | c | c | } 
\hline \text { Income } & \text { Total Utility } \
\hline \$ 0 & 0 \
\hline \$ 20,000 & 25 \
\hline \$ 40,000 & 45 \
\hline \$ 60,000 & 60 \
\hline \$ 80,000 & 70\
\hline
\end{array}$$
-Refer to Table 17.1. From the table, we can see that Jane is ________.

Accepted Answer

A)  risk averse 
B)  risk loving 
C)  risk neutral 
D)  We cannot determine Jane's attitude toward risk from the table.

Question 7

Expected value and expected utility are synonyms.

Accepted Answer

A) True 
 B)False

Question 8

You cause an automobile liability insurance company to face a moral hazard problem when you take ________ driving precautions ________ you buy automobile liability insurance from the company.

Accepted Answer

A)  fewer; after 
B)  more; after 
C)  fewer; before 
D)  the same; before and after

Question 9

For a risk averse individual, marginal utility of income does not diminish.

Accepted Answer

A) True 
 B)False

Question 10

Refer to the data provided in Table 17.2 below to answer the following questions. The table shows the relationship between income and utility for Sue.
Table 17.2
 $$\begin{array} { | c | c | } 
\hline \text { Income } & \text { Total Utility } \
\hline \$ 0 & 0 \
\hline \$ 20,000 & 20 \
\hline \$ 40,000 & 40 \
\hline \$ 60,000 & 60 \
\hline \$ 80,000 & 80\
\hline
\end{array}$$
-Refer to Table 17.2. From the table, we can see that Sue is ________.

Accepted Answer

A)  risk averse 
B)  risk loving 
C)  risk neutral 
D)  We cannot determine Sue's attitude toward risk from the table.

Question 11

As a result of adverse selection problems in the health insurance market, it is likely that over time

Accepted Answer

A)  fewer healthy people will be insured. 
B)  fewer unhealthy people will be insured. 
C)  fewer healthy and unhealthy people will be insured. 
D)  more healthy people will be insured.

Question 12

Consider the following game. You pick a card from a deck and each time you select an ace, you get $260. For all other cards you must pay $13. What is the expected value of the game?

Accepted Answer

A)  -$12 
B)  $0 
C)  $8 
D)  $32

Question 13

Refer to the data provided in Table 17.1 below to answer the following questions. The table shows the relationship between income and utility for Jane.
Table 17.1
 $$\begin{array} { | c | c | } 
\hline \text { Income } & \text { Total Utility } \
\hline \$ 0 & 0 \
\hline \$ 20,000 & 25 \
\hline \$ 40,000 & 45 \
\hline \$ 60,000 & 60 \
\hline \$ 80,000 & 70\
\hline
\end{array}$$
-Refer to Table 17.1. Suppose Jane has a 1/3 chance of becoming disabled in any given year. If she does become disabled, she will earn $0. If Jane does not become disabled, she will earn her usual salary of $60,000. Jane has the opportunity to purchase disability insurance for $20,000 which will pay her her full salary in the event she becomes disabled. Jane's utility per year with the policy is ________ and her expected utility without the policy is ________.

Accepted Answer

A)  45; 40 
B)  45; 45 
C)  60; 40 
D)  20; 45

Question 14

Consider the following game. You roll a six-sided die and each time you roll a 6, you get $30. For all other outcomes you pay $6. Since the expected value of this game is $0, the game is called a(n) ________.

Accepted Answer

A)  gamble 
B)  fair bet 
C)  even game 
D)  zero sum game

Question 15

Refer to the data provided in Table 17.2 below to answer the following questions. The table shows the relationship between income and utility for Sue.
Table 17.2
 $$\begin{array} { | c | c | } 
\hline \text { Income } & \text { Total Utility } \
\hline \$ 0 & 0 \
\hline \$ 20,000 & 20 \
\hline \$ 40,000 & 40 \
\hline \$ 60,000 & 60 \
\hline \$ 80,000 & 80\
\hline
\end{array}$$
-Refer to Table 17.2. Sue earns $40,000 annually. She has the opportunity to bet her entire salary on the upcoming super bowl. If Sue takes the bet, she will pick the Patriots. She believes that the Patriots have a 50-50 chance of winning the game. If the Patriots win, Sue will double her money ($80,000) but if they lose she loses her entire salary ($0). Sue's utility if she does not take the bet is ________ and her expected utility from the bet is ________.

Accepted Answer

A)  40; 80 
B)  40; 40 
C)  40; 0 
D)  80; 20

Question 16

Warranties, education, extracurricular activities are all examples of

Accepted Answer

A)  market signals. 
B)  risk premiums. 
C)  tools that can correct the moral hazard problem. 
D)  incentives.

Question 17

Relating to the Economics in Practice on page 361: Which of the following is an example of an advertisement in which the fact that something is NOT mentioned indicates that the product is unlikely to be desirable?

Accepted Answer

A)  an advertisement for hot dogs that mentions that it meets certain religious dietary requirements but fails to explain those requirements in a way that would be understood by most people 
B)  an advertisement for a sneaker that mentions the endorsement of one sports star but fails to mention the sports stars that have endorsed competing products 
C)  an advertisement for a 30-year old lawn tractor that mentions the color of its paint and the number of cup holders it has but makes no mention of the condition of its engine 
D)  an advertisement for ice cream that describes the variety of flavors available and the way it tastes but makes no mention of the ice cream's nutritional content

Question 18

Consider the following game. You roll a six-sided die and each time you roll a 6, you get $30. For all other outcomes you pay $6. The $30 when you "win" and the -$6 when you "lose" are called ________.

Accepted Answer

A)  payoffs 
B)  tradeoffs 
C)  incentives 
D)  expected values

Question 19

Refer to the data provided in Table 17.2 below to answer the following questions. The table shows the relationship between income and utility for Sue.
Table 17.2
 $$\begin{array} { | c | c | } 
\hline \text { Income } & \text { Total Utility } \
\hline \$ 0 & 0 \
\hline \$ 20,000 & 20 \
\hline \$ 40,000 & 40 \
\hline \$ 60,000 & 60 \
\hline \$ 80,000 & 80\
\hline
\end{array}$$
-Refer to Table 17.2. Sue earns $40,000 annually. She has the opportunity to bet her entire salary on the upcoming super bowl. If Sue takes the bet, she will pick the Patriots. She believes that the Patriots have a 50-50 chance of winning the game. If the Patriots win, Sue will double her money ($80,000) but if they lose she loses her entire salary ($0). This bet can be characterized as ________.

Accepted Answer

A)  risk neutral 
B)  an unfair bet 
C)  a fair bet 
D)  risk loving

Question 20

A diagram of an individual's utility from income will be a line with a constant slope if the individual is risk neutral.

Accepted Answer

A) True 
 B)False

Exam 17: Uncertainty and Asymmetric Information

Adverse selection is a situation in which asymmetric information results in low-quality goods or low-quality consumers being squeezed out of transactions because they are unable to demonstrate their quality.

Refer to the information provided in Figure 17.1 below to answer the questions that follow. Figure 17.1 -Refer to Figure 17.1. Suppose John's utility from income is given in the figure. From this we would say that John is ________.

A lender faces a(n) ________ problem when the lender lends funds to a borrower for a specific purpose and the borrower then opportunistically uses the funds for another purpose.

Expected value and expected utility are synonyms.

You cause an automobile liability insurance company to face a moral hazard problem when you take driving precautions you buy automobile liability insurance from the company.

For a risk averse individual, marginal utility of income does not diminish.

As a result of adverse selection problems in the health insurance market, it is likely that over time

Consider the following game. You pick a card from a deck and each time you select an ace, you get $260. For all other cards you must pay $13. What is the expected value of the game?

Consider the following game. You roll a six-sided die and each time you roll a 6, you get $30. For all other outcomes you pay $6. Since the expected value of this game is $0, the game is called a(n) ________.

Warranties, education, extracurricular activities are all examples of

Relating to the Economics in Practice on page 361: Which of the following is an example of an advertisement in which the fact that something is NOT mentioned indicates that the product is unlikely to be desirable?

Consider the following game. You roll a six-sided die and each time you roll a 6, you get $30. For all other outcomes you pay $6. The $30 when you "win" and the -$6 when you "lose" are called ________.

A diagram of an individual's utility from income will be a line with a constant slope if the individual is risk neutral.