Microeconomics (4.1.2.2)

Question 1

Define imperfect information

Answer 1

When the parties of a transaction have different information, not fully knowing the facts.

Question 2

What can imperfect information lead to?

Answer 2

Can lead to irrational behavior

            THEN

Market failure

            RESULTING IN

Failure to achieve optimal allocation.

Question 3

Define market

Answer 3

Interaction of buyers ans sellers to determine both the amount consumed and price at which each unit is consumed at.

Question 4

Define asymmetric information

Answer 4

When either or both parties in a transaction have incomplete or inaccurate information, which may lead to irrational decisions.

Question 5

Define information failure

Answer 5

A type of market failure where individuals or firms have a lack of information about economic decisions

Question 6

Demonstrate a way in which asymmetric information can be represented in a transaction

Answer 6

• The seller can know more than the buyer (e.g. car dealerships)
• Or the buyer can know more than the seller (3rd party organisations investigating into matter)

Question 7

Give an example where asymmetric information would be a problem

Answer 7

Car dealerships, drug dealers can sell “lemons” or “peaches”

Question 8

Define a peach

Answer 8

Products that are not up to the standard the consumer thinks or expects

Question 9

Define a lemon

Answer 9

Opposite of a peach - products up to the standard the consumer expects

Question 10

What can asymmetric information lead to?

Answer 10

Market failure - not enough resources allocated so too few cars/products are bought.

Question 11

What is another term for asymmetric information?

Answer 11

Information failure/gaps

Question 12

State causes for information failure happening

Answer 12

• Misunderstanding the true costs/benefits
• Uncertainty about the costs - e.g. should one buy a pension scheme when the conditional state of it is only identifiable in the future
• In general - complexity of situation

Question 13

Give examples of information failure

Answer 13

• Addiction to drugs (Unaware of side effects initially)
• Incomplete knowledge of food nutritional content
• Second hand goods (Unaware of actual condition)
• Complexity of pension schemes

Question 14

Define moral hazard

Answer 14

When people engage in risky behavior knowing they won’t bear the risk.`

Question 15

Give an example of moral hazard

Answer 15

When an insured consumer takes a risky course of action assuming they will be fully protected from any consequences - e.g. being careless with mobile devices

Question 16

Define adverse selection

Answer 16

When buyers or sellers of a product or service are able to use their private knowledge of the risk factors involved in the transaction to maximize their outcomes, at the expense of the other parties to the transaction.

Question 17

Give an example of adverse selection

Answer 17

Where those most likely to purchase health insurance are those who are more likely to use it, e.g. smokers, chronic health problems.

Question 18

What is another term for adverse selection?

Answer 18

Antiselection

Question 19

How is adverse selection carried out by legal entities such as firms? And what may it lead to?

Answer 19

E.g.

1) Health insurance companies raise prices for people who are more likely to use the service (people with chronic health problems)
2) Healthy consumers are forced out of the market so only high risk consumers get insurance
3) This may lead to market failure as there is a lack of resources allocated to everyone in the market.