CH 19 FINAL

Question 1

Adverse selection can occur when
A) all persons involved in a transaction have full information.
B) one person has information not available to others.
C) post-agreement incentives result in workers shirking.
D) nobody has any information about a particular product

Answer 1

B) one person has information not available to others.

Question 2

In the automobile insurance market, adverse selection occurs when
A) drivers with greater risks buy a policy with large deductibles.
B) drivers with greater risks buy a policy with no deductibles.
C) uninsured drivers drive recklessly.
D) insured drivers drive recklessly.

Answer 2

B) drivers with greater risks buy a policy with no deductibles.

Question 3

If reckless drivers are more likely to buy automobile insurance than safe drivers are,
A) a moral hazard has occurred.
B) adverse selection has occurred.
C) the market for insurance is efficient.
D) then automobile insurance will be fairly priced.

Answer 3

B) adverse selection has occurred.

Question 4

If adverse selection exists in a market,
A) it increases consumer surplus but reduces producer surplus.
B) it reduces consumer and producer surplus.
C) it reduces producer surplus but has no impact on consumer surplus.
D) it increases both consumer and producer surplus.

Answer 4

B) it reduces consumer and producer surplus.

Question 5

With asymmetric information firms might be reluctant to improve the quality of their
products because
A) it costs them more to produce the better quality product.
B) they are not able to completely capture the benefits of the improvement.
C) consumers do not value the better product.
D) consumers are better informed about the product and value the new product less.

Answer 5

B) they are not able to completely capture the benefits of the improvement.

Question 6

What could be a potential explanation for a firm selling virtually identical products under
different brands?
A) Consumers are well informed about the quality of the products.
B) Consumers believe that the products’ quality is similar and thus firms are able to price
discriminate.
C) Consumers always favor private-label brands.
D) Consumers believe that the products’ quality differs and thus firms are able to price
discriminate.

Answer 6

D) Consumers believe that the products’ quality differs and thus firms are able to price
discriminate.

Question 7

Suppose that everyone is risk neutral and buyers cannot identify the lemons. The expected
value of a used car is $8,000. No good cars will be sold in this market
A) unless the sellers of good cars place a value greater than $8,000 on their cars.
B) unless the sellers of lemons place a value greater than $8,000 on their cars.
C) unless sellers engage in cheap talk.
D) unless the sellers of good cars place a value lesser or equal to $8,000 on their cars.

Answer 7

D) unless the sellers of good cars place a value lesser or equal to $8,000 on their cars.

Question 8

Used car buyers will believe that a car is of good quality when the seller signals the car’s high
quality by offering a warranty when
A) a warranty on a lemon is costly to the seller.
B) warranties are offered on all cars.
C) warranties are only offered on lemons.
D) a warranty on a good car is a false signal.

Answer 8

A) a warranty on a lemon is costly to the seller.

Question 9

If a life insurance company does not require a medical exam of its policyholders, it is most
likely that the company
A) charges above-average premiums.
B) charges below-average premiums.
C) charges no premiums.
D) has only very healthy policyholders.

Answer 9

A) charges above-average premiums.

Question 10

If a student achieves a high SAT score, this
A) sends a signal to a college that the applicant will be a good college student.
B) does not act as a screening device.
C) is a moral hazard.
D) provides a college with no information.

Answer 10

A) sends a signal to a college that the applicant will be a good college student.

Question 11

If bad drivers can usually avoid being ticketed by the police, then insurance companies will
A) use one’s driving record as a signal.
B) use one’s driving record as a screening device.
C) not be able to use one’s driving record as a screening device.
D) request driving records directly from the police and not from the individual applicant.

Answer 11

C) not be able to use one’s driving record as a screening device.

Question 12

Assume health insurance is provided universally by the government. This would
A) force every taxpayer to bear the costs of adverse selection.
B) force every taxpayer to bear the costs of moral hazard.
C) force the government to deal with adverse selection problems.
D) force foreign governments to deal with moral hazard problems.

Answer 12

B) force every taxpayer to bear the costs of moral hazard.

Question 13

) Signals may prevent adverse selection if
A) sending a false signal is cheap for the agent.
B) sending a false signal is costly for the agent.
C) agents as rational.
D) signals are as good as cheap talk.

Answer 13

B) sending a false signal is costly for the agent.

Question 14

Screening is the action
A) taken by an informed person to determine the information possessed by uninformed people.
B) taken by an uninformed person to determine the information possessed by informed people.
C) taken to offset signaling.
D) that is cheaper and more effective than cheap talk.

Answer 14

B) taken by an uninformed person to determine the information possessed by informed people.

Question 15

Competitive firms are able to set price above marginal cost when
A) the markup is less than the cost of going to another store.
B) the markup is greater than the cost of going to another store.
C) all consumers have full information.
D) consumers know what other stores are charging.

Answer 15

A) the markup is less than the cost of going to another store.

Question 16

When consumers have asymmetric information and when search costs and the number of
firms are large, a single-price equilibrium in a competitive market
A) is impossible.
B) occurs when price equals average cost.
C) occurs when price equals marginal cost plus the search cost.
D) occurs when the price is the price a monopoly would set.

Answer 16

D) occurs when the price is the price a monopoly would set.

Question 17

If there is zero search cost, then in the presence of asymmetric information, competitive firms
will
A) charge the monopoly price.
B) charge the competitive price.
C) charge zero price.
D) shut down.

Answer 17

B) charge the competitive price.

Question 18

In the context of insurance markets, adverse selection occurs when:
A. Insurers are unable to differentiate between high-risk and low-risk customers due to lack of information.
B. Customers have more information about their health status than the insurers.
C. Risk-averse individuals are more likely to buy insurance than risk-takers.
D. All of the above.

Answer 18

D. All of the above.

Question 19

Which of the following is a common solution for reducing adverse selection in the health insurance market?
A. Charging everyone the same premium
B. Offering only high-deductible plans
C. Requiring mandatory disclosure of medical history
D. Requiring everyone to purchase insurance

Answer 19

D. Requiring everyone to purchase insurance

Question 20

How might adverse selection affect the market for life insurance?
A. People with high-risk lifestyles are less likely to seek life insurance.
B. People with knowledge of their poor health are more likely to seek life insurance.
C. Insurers are more likely to insure those who require minimal medical care.
D. All individuals pay the same premium, reducing risk.

Answer 20

B. People with knowledge of their poor health are more likely to seek life insurance.

Question 21

Moral hazard refers to:
A. The tendency of individuals to take more risks when they are not bearing the full cost of those risks.
B. The risks associated with unethical behavior in financial markets.
C. The hazards that arise from immoral actions in society.
D. The risk that a party has not entered into a contract in good faith.

Answer 21

A. The tendency of individuals to take more risks when they are not bearing the full cost of those risks.

Question 22

In the context of employment, moral hazard is most likely to occur when:
A. Employees are paid based solely on their performance.
B. There is clear monitoring of employee activities.
C. Employees are given a fixed salary regardless of their output.
D. Employees have to share their profits with the employer

Answer 22

C. Employees are given a fixed salary regardless of their output.

Question 23

How can companies mitigate moral hazard when employees work remotely?
A. By reducing the number of remote work days
B. By implementing stricter hiring criteria
C. By using performance-based incentives and regular progress reviews
D. By lowering salaries to offset the risk of decreased productivity

Answer 23

C. By using performance-based incentives and regular progress reviews

Question 24

Asymmetric information occurs when:
A. One party has more or better information than the other in a transaction.
B. Both parties have the same information.
C. Information is symmetrically distributed among all parties.
D. None of the above.

Answer 24

A. One party has more or better information than the other in a transaction.

Question 25

. Which of the following best illustrates a solution to the problem of asymmetric information in used car sales?
A. The seller providing a detailed history report of the car.
B. The buyer taking the car for a test drive only.
C. The seller offering a lower price than the market average.
D. The buyer deciding to trust the seller’s verbal assurance of the car’s condition.

Answer 25

A. The seller providing a detailed history report of the car.