MC from finals

Question 1

Which of the following features of the recent financial crisis is inconsistent with the usual assumptions of the economic models:

Answer 1

Mortgage-backed securities were so far removed from their underlying assets that no one could assess their true risk.

Question 2

IS “people have very different valuations of the same good” a valid critique of contingent valuation methods?

Answer 2

yes

Question 3

12. Imagine two proposals for funding a new state park. Under the first scenario, the park would be funded entirely by state taxes and would have no user fees. Under the second scenario, there would be an entry fee to use the park. This fee would offset some of the costs, so less tax funding would be needed. The fee would be set low enough that it didn’t measurably change demand for the park. According to the Kaldor-Hicks criterion:

Answer 3

We are indifferent between the two scenarios

Question 4

An actuarially fair premium is one that is equal to

Answer 4

the expected pay out

Question 5

Insurance is…

Answer 5

pooling risk, so the risks must be uncorrelated

Question 6

Diversification is..

Answer 6

spreading risk, so they must be uncorrelated or negatively correlated

Question 7

People are often…

Answer 7

risk averse with respect to gains, and risk seeking with respect to losses (loss aversion)

Question 8

Asymmetric Information

Answer 8

1. ) Moral Hazard
2. ) Adverse Selection
3. ) Principal-Agent Problems

Question 9

To find out the most someone is willing to pay for insurance you must calculate both actuarially fair premium and

Answer 9

certain wealth equivalent

Question 10

What are some of the five ways to address adverse selection?

Answer 10

1. ) Universal Insurance
   a. ) Government Provided
   b. ) Mandated
2. ) Limiting Lemons: “Lemon Laws”
   a. ) Consumer Protection
3. ) Screening
4. ) Signaling
5. ) Standards and Certification

Question 11

What are the five basic steps of risk aversion in relation to expected wealth?

Answer 11

1. ) E(W)
2. ) U(E(W))
3. ) E(U(W))
4. ) ln(w) = CWE
5. ) WTP = AFP + RP

Question 12

What are the approaches to induce effort?

Answer 12

1. ) Investments in monitoring tech
2. ) Bonding
3. ) Deferred Compensation
4. ) Efficiency Wages

Question 13

What are the criticisms of agency theory?

Answer 13

1. ) You might want to work based on mission?
2. ) Assumes goals of principal & agent are (at least partly) in conflict. Means that relationships supposedly start in conflict

Question 14

What theory was developed to explain relationships devoid of the criticisms of agency theory?

Answer 14

Stewardship Theory

Question 15

What are contract design objectives?

Answer 15

1. ) Participation Constraints
2. ) Incentive Compatibility
3. ) Balance efficiency in production and efficiency in risk bearing

Question 16

Risk Averse means…

Answer 16

a diminishing marginal utility as wealth increases

Question 17

Risk Seeking…

Answer 17

means increasing marginal utility as wealth increases

Question 18

Market Failure…

Answer 18

Moral Hazard: Consuming too much of wrong thing and too little of the right thing

Adverse Selection: cream skimming and small numbers of hospitals and insurance cases

Question 19

From Class Notes, what were the 4 Market Failures that led to the 2008 financial crisis?

Answer 19

1. ) Moral Hazard: Banks assumed they’d be bailed out.
2. ) Principal-Agent: Mortgage providers gave loans that benefited them, the agent, to the detriment of banks, the principals.
3. ) Imperfect Info: The people getting loans were not fully informed.
   a. ) Credit agencies were not accurately rating, and this could also fall under principal agent, since they were paid by mortgage security holders.
   b. ) Some securities were so complex their risk couldn’t be calculated.
4. ) Externalities: Other markets & institutions were negatively effected by the crash.

Question 20

What should the government do and did they do the right thing?

Answer 20

1. ) The government made money, but did those profits cover the total externality?
2. ) The government may have made money, but those with lower income likely lost money, and this has equity implications.
3. ) The same principal agent problems from corporate governance (Ex: CEO) still exist today.

just some examples

Question 21

What was the last big juxtaposition for possibly addressing this problem in the future?

Answer 21

1.) Do we bail out in the future?
vs.
2.) Do we increase the regulatory environment?

Question 22

What was kind of the big overarching question Vigdor used to frame the course in the final lecture?

Answer 22

How do people following their own self-interest lead to suboptimal outcomes?

Question 23

Public Goods, how is this ppl following their own self-interest and resulting in suboptimal outcomes?

Answer 23

Ppl tend to free ride and this is rational.

Question 24

What is adverse selection a subcategory of?

How doe sit show ppl following their own self interest leading to a sub optimal outcome?

Answer 24

1. ) Asymmetric Information
2. ) Prices are based on averages or averages in things like insurance so some people get a good deal and others leave the market.

Question 25

What is moral hazard a subcategory of?

How doe smoral hazard encapsulate ppl acting rationally and affecting society suboptimally?

Answer 25

1. ) Asymmetric Information

2. ) People don’t face full cost of their actions on the margin.

Question 26

How do principal-agent problems lead to ppl acting rationally and achieving suboptimal social results?

Answer 26

Incentives don’t line up and so each party acts to maximize their utility. This may not be best.