Ch. 20

Question 1

extent decision

Answer 1

a decision regarding how much or how many of a product to produce.

change level of advertising, increase quality of service, larger or smaller staff, how many parking spaces to lease?

Question 2

For extent decisions, we break the decision into small steps–

Answer 2

If taking a step provides more benefit than cost, take a step forward–If not, step backward

If the benefits of selling another unit (MR) are bigger than the costs (MC), then sell another unit.

Question 3

Maxim:

Answer 3

–Produce more when MR>MC

–Produce less when MR

Question 4

example of Progressive is an example of adverse selection as another factor

Answer 4

gathers information from consumers who purchase insurance regarding different risks.

some of the risky driving behavior is caused by the insurance itself.

Question 5

Progressive: decision on how much or how fast to drive is an

Answer 5

extent decision.

The marginal benefit of driving more or at faster speeds is obvious. The marginal cost is the cost of gasoline and wear on the car and the increased risk of accident. Once you buy insurance, the cost of getting into an accident goes down, so we would expect to see more accidents.

Question 6

behavior on progressive case is called

Answer 6

moral hazard

Question 7

moral hazard

Answer 7

post-contractual increases in risky or negative behavior.

Question 8

Examples of moral hazard are ___________ to exercise care once you purchase insurance and ___________ to work hard once you have been hired.

Answer 8

reduced incentives (x2)

Question 9

Moral hazard is similar to adverse selection in that it is caused by __________; it differs in that it is caused by hidden _______ rather than hidden types.

Answer 9

information asymmetry

actions

Question 10

Insurance companies anticipate that insured drivers drive ______ carefully, and they price policies accordingly.

Answer 10

less

Question 11

moral hazard refers to

Answer 11

the reduced incentive to exercise care once you purchase insurance

Question 12

social capital as a motivator helps with

Answer 12

adverse selection

ex: Lendo - algorithm

Question 13

Lendo

Answer 13

extra incentive by affecting friends and family’s ability to borrow.

social sanctions

Question 14

moral hazard is

Answer 14

ubiquitous (being everywhere at the same time/constantly encountered).

Question 15

All these costly technologies reduce the costs of risk taking, which leads to ______ risk taking.

Answer 15

more

Question 16

both moral hazard and adverse selection are caused by information asymmetry.

Answer 16

moral hazard by hidden actions

adverse selection by hidden information

Question 17

moral hazard and hidden actions

Answer 17

insurance companies cannot observe driving behavior

Question 18

adverse selection and hidden information

Answer 18

insurance companies cannot observe the inherent risks that you face.

Question 19

both moral hazard and adverse selection can be solved by removing

for example:

Answer 19

information asymmetry

-monitoring or changing incentives of individuals

Question 20

Moral Hazard occurs when:

a. People are more likely to decide on a course of action when they do not bear the costs of the decision.	
b. Technologies that reduce risks make people more careful.	
c. People take fewer risks when others bear the costs of these risks.	
d. People are less careful when they safer technologies are not available.

Answer 20

a. People are more likely to decide on a course of action when they do not bear the costs of the decision.

Question 21

Examples of Moral Hazard are:

a. Dock workers without back-support belts lift heavier weights.	
b. A company borrowing for mobile phone spectrum paying off all debts even if the system is losing money.	
c. A football player with less protective gear playing rougher.	
d. A driver with all passenger airbags driving slightly more recklessly.

Answer 21

d. A driver with all passenger airbags driving slightly more recklessly.

Question 22

anticipate moral hazard and if you can figure out how to

Answer 22

consummate the implied wealth creating transactions

Question 23

moral hazard means insured consumers exercise ______ care because they have _____ incentive to do so.

Answer 23

less (x2)

Question 24

anticipate moral hazard and

Answer 24

protect yourself against it

Question 25

moral hazard can represent an opportunity to ___________ as it represents an unconsummated wealth-creating transaction.

Answer 25

make money as it

Question 26

Insured customers:

a. Exercise more care because they have less incentive to do so.	
b. Exercise less care because they have less incentive to do so.	
c. Exercise more care because they have more incentive to do so.	
d. Exercise less care because they have more incentive to do so.

Answer 26

b. Exercise less care because they have less incentive to do so.

Question 27

Examples of insurance companies protecting themselves against moral hazard are:

a. Free annual physical exams.	
b. Buying locks for insured bicycles.	
c. Requiring repairs that homeowners make to their houses conform to building codes.	
d. All of the above.

Answer 27

d. All of the above.

Question 28

If moral hazard exists in insurance markets:

a. There are no uninsured customers who would like insurance.	
b. Insurance companies have sold insurance to all potential customers.	
c. There is the potential for another transaction to be wealth-creating.	
d. No customers bear more risk than they would like to.

Answer 28

c. There is the potential for another transaction to be wealth-creating.

Question 29

Moral hazard and adverse selection often offer __________ for the same observed behavior.

Answer 29

competing explanations

Question 30

What distinguishes adverse selection from moral hazard is the kind of knowledge that is hidden from the insurance company.

Adverse selection arises from hidden information regarding the type of person (high versus low risk) who is purchasing insurance.

Moral hazard arises from hidden actions by the person purchasing insurance (taking care or not).

Answer 30

Adverse selection is the problem of separating you from someone else.

Moral hazard is the problem of separating the good you from the bad you.

Question 31

Which of the following are examples of moral hazard:

a. Poor drivers purchase cars with anti-lock brakes.	
b. People living in areas with more theft buy more theft insurance.	
c. People living along the river buy more flood insurance.	
d. Drivers with anti-lock brakes drive in ice and rain.

Answer 31

d. Drivers with anti-lock brakes drive in ice and rain.

Question 32

The difference between moral hazard and adverse selection is:

a. Moral hazard has to do with hidden information about counter-party types.	
b. Adverse selection refers to actions taken after a transaction has occurred.	
c. Moral hazard has to do with hidden information about counter-party behaviors.	
d. Adverse selection has to do with hidden information about counter-party behaviors.

Answer 32

c. Moral hazard has to do with hidden information about counter-party behaviors.

Question 33

Shirking is a type of moral hazard caused by

Answer 33

the difficulty or cost of monitoring employees’ behavior after a firm has hired them.

Question 34

If there is no solution, then

Answer 34

there is no problem.

Question 35

moral hazard hurts

Answer 35

both parties to a transaction

Question 36

Shirking on the job is a version of moral hazard because:

a. Workers will exert less effort if there is no reward to exerting more effort.	
b. Managers can observe the amount of effort workers exert.	
c. Workers get paid for exerting effort even if it does not generate a sale.	
d. Managers can always observe the amount of effort a worker undertakes.

Answer 36

a. Workers will exert less effort if there is no reward to exerting more effort.

Question 37

When managers choose to allow workers to engage in some shirking, it is because:

a. It would be profitable to set a high enough reward to induce the appropriate effort.	
b. The metric used to evaluate workers is a perfect measure of the effort they exerted.	
c. Workers do not receive any payment when they shirk.	
d. The amount workers would have to be compensated to stop shirking is not worth it.

Answer 37

d. The amount workers would have to be compensated to stop shirking is not worth it.

Question 38

bank problems with lending - adverse selection

Answer 38

borrowers who are less likely to repay loans are more likely to apply for them.

Question 39

bank problems with lending - moral hazard

Answer 39

once a loan is made, the borrower is likely to invest in more risky assets

Question 40

both bank problems involving moral hazard and adverse selection

Answer 40

make repayment less likely

Question 41

borrowers prefer riskier investments because

Answer 41

they get more upside, while the lender bears more of the downside.

Question 42

borrowers who have nothing to lose _________ this moral hazard problem.

Answer 42

exacerbate (make it worse)

Question 43

Banks guard against moral hazard by _________ the behavior of borrowers and by placing __________ on loans to ensure that the loans are used for their intended purpose.

Answer 43

monitoring

covenants

Question 44

moral hazard can be characterized as an ________ between a lender and a borrower because it puts other people’s money at risk.

Lender /borrower prefer less risky = higher expected payoff

Answer 44

incentive conflict

Question 45

moral hazard is a problem for

Answer 45

both the lender and the borrower.

Question 46

Borrowers take bigger risks with ________ than they would with their own.

Answer 46

other people’s money

Question 47

to control lender moral hazard, lenders find incentives for borrowers for example,

Answer 47

putting borrower’s own money at risk. so the borrower and lender share the downside.

Question 48

Moral hazard occurs in lending because:

a. Lenders have an incentive to fund riskier projects after the funds have been allocated.	
b. Borrowers have an incentive to fund riskier projects after the funds have been allocated.	
c. Lenders are eventually paid in full even when borrowers must default because a project failed.	
d. Borrowers only want to allocate funds to lender approved projects.

Answer 48

b. Borrowers have an incentive to fund riskier projects after the funds have been allocated.

Question 49

To avoid moral hazard in lending, lenders try to:

a. Place tight restrictions on how the lent funds can be used.	
b. Require that a portion of the project is funded by the borrowers own funds.	
c. Lend to borrowers who have assets to seize in case of default.	
d. All of the above

Answer 49

d. All of the above.

Question 50

Regulators can reduce the costs of moral hazard by ensuring that banks keep an ______________ so that they can repay depositors who want their money back.

Answer 50

equity “cushion” of about 10%

Question 51

in banks - When the value of the assets fall, the risk of moral hazard _______.

Answer 51

increases

Question 52

Banks earn money on the spread between the ________ they receive from their loans and the ________ they pay to depositors.

Answer 52

interest (x2)

Question 53

2008 financial crisis

Answer 53

responsible borrowers are punished twice—once by sharing in the bailout and again when they face higher loan rates.

Question 54

Foreclosure protection for homeowners and expanding borrower rights in the aftermath of the financial crisis:

a. Benefited responsible homeowners who did not purchase houses they could not afford.	
b. Benefited responsible homeowners because the terms for new loans became less expensive.	
c. Benefited irresponsible homeowners because they did not have to pay back the full loans on expensive houses.	
d. Benefited irresponsible homeowners because the terms for new loans became less expensive.

Answer 54

c. Benefited irresponsible homeowners because they did not have to pay back the full loans on expensive houses.