Question 1

Moral hazard occurs when one party to a contract changes his behavior in response to that contract and thus passes on costs of that behavior to the other party.

Accepted Answer

This is the definition of moral hazard. When one party in a contract knows that the other party will bear the costs of their actions, they may take more risks or behave recklessly, leading to negative consequences for the other party.

Question 2

Moral hazard can do harm to one party to a contract, but always results in efficient behavior.

Accepted Answer

Moral hazard can lead to inefficient behavior as one party may take on more risk or engage in risky behavior due to the belief that the cost of negative outcomes will be borne by the other party or a third party. This can result in negative consequences for both parties in the long term.

Question 3

Jim used to be very careful with his car. However, once he bought full auto insurance on it, he stopped turning on his alarm or even locking it when parking it. This is an example of moral hazard.

Accepted Answer

Moral hazard refers to the increased risk-taking behavior that an individual may engage in because they are protected from the financial consequences of their actions through insurance or other means. In this scenario, Jim's behavior of being less careful with his car after purchasing full auto insurance is an example of moral hazard.

Question 4

Relating to the Economics in Practice on page 356: Huntington's disease is an inheritable disorder which affects 1 in 10,000 individuals, and since 1993 there has been a test that perfectly predicts the disease. Presently, insurance companies are not legally allowed to inquire about the results of genetic tests. This has led to ________ favoring potential insurance buyers.
A) moral hazard
B) asymmetric information
C) market signaling
D) adverse selection

Accepted Answer

The answer of Relating to the Economics in Practice on...

Question 5

Jim used to be very careful with his car. However, once he bought full auto insurance on it, he stopped turning on his alarm or even locking it when parking it. This is an example of adverse selection.

Accepted Answer

This is an example of moral hazard, not adverse selection. Moral hazard occurs when someone takes more risks because they are insulated from the consequences, such as being less careful with a car because it's fully insured. Adverse selection involves a party using information that the other party is unaware of, to make a decision.

Question 6

The insurance industry is susceptible to adverse selection problems, but not problems of moral hazard.

Accepted Answer

The insurance industry is susceptible to both adverse selection problems and problems of moral hazard. Adverse selection refers to the tendency for individuals with a higher risk of loss to be more likely to purchase insurance, while moral hazard refers to the tendency for individuals to take greater risks or engage in riskier behavior once they have insurance. Both of these can lead to higher costs and losses for the insurance company.

Question 7

Relating to the Economics in Practice on page 360: The smart phone app which allows skiers at a slope to report weather conditions to others could be considered a form of
A) moral hazard.
B) market signaling.
C) asymmetric information.
D) risk-loving.

Accepted Answer

The smart phone app that allows skiers to report weather conditions to others is an example of market signaling because it provides information to other skiers about the conditions on the slope. Market signaling is when one party provides information to another party in order to influence their decision making. In this case, the skiers who report the weather conditions are signaling to other skiers whether or not it is safe to ski on the slope. Moral hazard, asymmetric information, and risk-loving are not applicable in this situation.

Question 8

Refer to the Economics in Practice on page 358. Sometimes the lack of information in an advertisement serves as a signal.

Accepted Answer

Sometimes advertisers intentionally leave out information in their ads as a signal to consumers that the product is high quality. This is known as signaling theory in economics.

Question 9

Refer to the Economics in Practice on page 358. Advertisements provide information in two ways-what they say and what they omit.

Accepted Answer

Advertisements can provide information not only through what they explicitly say, but also through what they suggest or imply. Additionally, they may selectively choose which information to include or omit in order to influence consumer behavior.

Question 10

Related to the Economics in Practice on page 358: Suppose you see the following advertisement for a vacation rental. "Beautiful condo on the Island of Maui (Hawaii). Sleeps 5. Great landscaped grounds, pool, and BBQ area. Lanai overlooks pool. $1,500 per week." It is likely true that the condo
A) doesn't have a view of the pool.
B) has no view other than the pool (i.e. no ocean, mountain, or city view).
C) is not on the island of Maui.
D) has an actual rental rate of $1600 per week.

Accepted Answer

The advertisement only mentions a view of the pool from the lanai, and there is no mention of any other view. Therefore, it is likely that the condo has no view other than the pool.

Question 11

Adverse selection is a situation in which asymmetric information results in low-quality goods or low-quality consumers being squeezed out of transactions because they are unable to demonstrate their quality.

Accepted Answer

Adverse selection is a situation where asymmetric information results in high-quality goods or high-quality consumers being squeezed out of transactions because they cannot distinguish themselves from low-quality goods or consumers.

Question 12

________ arises when one party to a contract changes behavior in response to that contract, passing the cost of that change in behavior to the other party.
A) Adverse selection
B) Moral hazard
C) Logrolling
D) Market signaling

Accepted Answer

This is the definition of moral hazard. The party changing behavior is taking advantage of the other party's reliance on their initial behavior, and passing the cost of the new behavior onto them. Adverse selection refers to when one party to a contract has information that the other party does not, leading to an unfair advantage. Logrolling refers to the practice of exchanging favors or support, often in politics. Market signaling refers to actions taken by a party to a contract to indicate their quality or intentions, often through costly or visible actions.

Question 13

Jacinda, a college student, waits tables at a local diner to earn extra cash. In order to differentiate herself from other wait staff, Jacinda took a life saving course from the local hospital, where she learned the proper procedures to use in cases of choking. This is an example of a market signal.

Accepted Answer

By taking the life saving course, Jacinda is signaling to her employer and customers that she is a more capable and skilled employee than other wait staff.

Question 14

Adverse selection and moral hazard are problems that arise in the presence of asymmetric information.

Accepted Answer

Adverse selection occurs when one party in a transaction has better information than the other and selectively chooses to disclose information that puts them in an advantageous position. Moral hazard occurs when one party takes more risks or engages in undesirable behavior because they are protected from the consequences of their actions, often because the other party does not have complete information about their actions. Asymmetric information is at the root of both problems.

Question 15

Annie, a high school student, babysits to earn extra cash. In order to differentiate herself from other babysitters, Annie took a babysitting course from the Red Cross. This is an example of a market signal.

Accepted Answer

By taking a babysitting course from the Red Cross, Annie is sending a market signal to potential clients that she is serious and committed to providing high-quality care for their children. This can help her stand out from other babysitters who may not have taken such a course.

Question 16

The insurance industry is susceptible to moral hazard problems, but not problems of adverse selection.

Accepted Answer

Adverse selection occurs when individuals with a higher risk of loss are more likely to purchase insurance, leading to an imbalance in the risk pool. This can result in higher premiums for everyone or even the collapse of the insurance market. Moral hazard, on the other hand, refers to the behavior of insured individuals changing in response to being insured. For example, someone who has car insurance may drive more recklessly because they know their insurance will cover any accidents.

Question 17

Relating to the Economics in Practice on page 356: A long-term study of Huntington's disease patients found that individuals who carry the Huntington's disease genetic mutation are up to five times as likely as the general population to buy long-term care insurance. This is an example of ________ in the health insurance market.
A) moral hazard
B) risk-loving
C) adverse selection
D) market signaling

Accepted Answer

This scenario is an example of adverse selection in the health insurance market. Adverse selection occurs when individuals who are at a higher risk of needing insurance are more likely to purchase it, leading to an imbalance of healthy and sick individuals in the insurance pool. In this case, individuals with the Huntington's disease genetic mutation are more likely to purchase long-term care insurance than the general population due to their higher risk of needing long-term care.

Question 18

Which of the following are examples of market signals?
A) warranties
B) education
C) extracurricular activities
D) all of the above

Accepted Answer

Market signals are various indicators or pieces of information that can influence the decisions of consumers, businesses, or investors. Warranties signal product quality and reduce consumer risk, education signals employee potential and skill level to employers, and extracurricular activities can signal an individual's broader skills and interests, impacting hiring decisions or market offerings.

Question 19

Moral hazard occurs when buyers and sellers take actions to communicate quality in a world of uncertainty.

Accepted Answer

Moral hazard occurs when one party in a transaction takes on more risk because they know the other party will bear the cost of those risks. It's not about communicating quality but about changing behavior after a deal is made, knowing that the consequences will fall on the other party.

Question 20

Moral hazard is a situation in which asymmetric information results in high-quality goods or high-quality consumers being squeezed out of transactions because they are unable to demonstrate their quality.

Accepted Answer

Moral hazard refers to a situation in which one party takes more risk because they believe the other party will bear the cost of their actions. This can occur when one party has more information than the other, such as in insurance or financial markets. It does not necessarily result in high-quality goods or consumers being squeezed out of transactions.

Quiz 17: Uncertainty and Asymmetric Information