MC from finals Flashcards
Which of the following features of the recent financial crisis is inconsistent with the usual assumptions of the economic models:
Mortgage-backed securities were so far removed from their underlying assets that no one could assess their true risk.
IS “people have very different valuations of the same good” a valid critique of contingent valuation methods?
yes
- 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:
We are indifferent between the two scenarios
An actuarially fair premium is one that is equal to
the expected pay out
Insurance is…
pooling risk, so the risks must be uncorrelated
Diversification is..
spreading risk, so they must be uncorrelated or negatively correlated
People are often…
risk averse with respect to gains, and risk seeking with respect to losses (loss aversion)
Asymmetric Information
- ) Moral Hazard
- ) Adverse Selection
- ) Principal-Agent Problems
To find out the most someone is willing to pay for insurance you must calculate both actuarially fair premium and
certain wealth equivalent
What are some of the five ways to address adverse selection?
- ) Universal Insurance
a. ) Government Provided
b. ) Mandated - ) Limiting Lemons: “Lemon Laws”
a. ) Consumer Protection - ) Screening
- ) Signaling
- ) Standards and Certification
What are the five basic steps of risk aversion in relation to expected wealth?
- ) E(W)
- ) U(E(W))
- ) E(U(W))
- ) ln(w) = CWE
- ) WTP = AFP + RP
What are the approaches to induce effort?
- ) Investments in monitoring tech
- ) Bonding
- ) Deferred Compensation
- ) Efficiency Wages
What are the criticisms of agency theory?
- ) You might want to work based on mission?
- ) Assumes goals of principal & agent are (at least partly) in conflict. Means that relationships supposedly start in conflict
What theory was developed to explain relationships devoid of the criticisms of agency theory?
Stewardship Theory
What are contract design objectives?
- ) Participation Constraints
- ) Incentive Compatibility
- ) Balance efficiency in production and efficiency in risk bearing
Risk Averse means…
a diminishing marginal utility as wealth increases
Risk Seeking…
means increasing marginal utility as wealth increases
Market Failure…
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
From Class Notes, what were the 4 Market Failures that led to the 2008 financial crisis?
- ) Moral Hazard: Banks assumed they’d be bailed out.
- ) Principal-Agent: Mortgage providers gave loans that benefited them, the agent, to the detriment of banks, the principals.
- ) 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. - ) Externalities: Other markets & institutions were negatively effected by the crash.
What should the government do and did they do the right thing?
- ) The government made money, but did those profits cover the total externality?
- ) The government may have made money, but those with lower income likely lost money, and this has equity implications.
- ) The same principal agent problems from corporate governance (Ex: CEO) still exist today.
just some examples
What was the last big juxtaposition for possibly addressing this problem in the future?
1.) Do we bail out in the future?
vs.
2.) Do we increase the regulatory environment?
What was kind of the big overarching question Vigdor used to frame the course in the final lecture?
How do people following their own self-interest lead to suboptimal outcomes?
Public Goods, how is this ppl following their own self-interest and resulting in suboptimal outcomes?
Ppl tend to free ride and this is rational.
What is adverse selection a subcategory of?
How doe sit show ppl following their own self interest leading to a sub optimal outcome?
- ) Asymmetric Information
- ) Prices are based on averages or averages in things like insurance so some people get a good deal and others leave the market.
What is moral hazard a subcategory of?
How doe smoral hazard encapsulate ppl acting rationally and affecting society suboptimally?
- ) Asymmetric Information
2. ) People don’t face full cost of their actions on the margin.
How do principal-agent problems lead to ppl acting rationally and achieving suboptimal social results?
Incentives don’t line up and so each party acts to maximize their utility. This may not be best.