Chapter 24:

Question 1

What is Asymmetric information and what is an example?

Answer 1

This occurs when one part has more information than the other.
Ex: A taxi driver knowing the routes of a city better than than visitors.

Question 2

When do markets work best.. . when traders know (what?)

Answer 2

Exactly what is being traded.

Question 3

T/F a party will likely stay in a trade if they feel the other party has an unfair information advantage that they lack.

Answer 3

This is false if one party knows the other has a lot more information it can cause the party to exit the trade.

Question 4

What is the principle agent problem?

• Defn
• Ex

Answer 4

Defn:
The principle or owner is hiring an agent or representative and this has to do with what incentives can be used to keep the agents interest aligned with principle, especially when the agent knowns more than the principle.
—————————————————————————-
ex: hiring a contractor to complete a repair on a home, retaining an attorney to perform legal work, or asking an investment advisor to diversify a portfolio

Question 5

In what situations does the principle agent problem exist in?

Answer 5

In any situation were you hire someone to do something else for you.

Question 6

What is moral hazard and how does it differ from asymmetric information?

Answer 6

Moral hazard is when an agent tries to exploit an information advantage in an undesirable or dishonest way.
- Moral hazard is using an asymmetric information advantage to perform something foul. (basically applying asymmetric information to benefit you in a transaction.)

Question 7

What is an advantage of moral hazard?

Answer 7

When a taxi driver knows someone is from out of town so he takes the long way to make some extra money.

Question 8

What are the problems associated with moral hazard?

Answer 8

1. ) create unnecessary work and waste time.
2. ) This can make parties less likely to buy something if you think there is a hazard their.
   - which can lead to the possibility of a loss of a mutual exchange.
3. ) This is a serious problem when decisions are difficult to reverse or expensive in nature.

Question 9

What are ways in which moral hazard, asymmetric information and principle agent problem can be avioded?

Answer 9

• Reviews, the internet, friends, etc. the internet is quite helpful.

Question 10

What is a free rider?

Answer 10

Someone who consumes the good but doesn’t pay for it.

Question 11

What does the book say is a good way to create a better incentive?

Answer 11

Splitting the selling of a service from the diagnosis of how much the service is needed can help reduce the moral hazard.
- Also performance based incentive (attorney or athlete)

Ex: you would never allow a home inspector to also make repairs on everything wrong you found with the house, you need to remove this incentive in order to keep him honest.

Question 12

T/F moral hazard isn’t limited to market places where transactions occur?

Answer 12

True, politicians and bureaucrats are have more information than the voters.

Question 13

What is adverse selection?

Answer 13

When an offer contains negative information about the product being offered. ( like someone not mentioning they have an alcohol addiction and being given the same insurance rate as someone who doesn’t) (or someone selling their care and advertising it as problem free even though it has plenty of problems.)

” the use of asymmetric information in a negative way prior to the agreement occurring”

Question 14

What are effect counter adverse selection techniques?

Answer 14

1. ) Things like the BBB
2. ) Warranties(signal)- ex: Hyundai’s were originally thought of as junk, but once they offered “America’s best warranty- 10 years or 100,000 miles) they significantly better in sales.

Question 15

What is a signal?

Answer 15

An expensive action that is taken to reveal information.

• warranty
• college degree

Question 16

Credible promise?

Answer 16

A promise that the promisor has an incentive to keep.