Question 1

Which of the following would be an example of a principal trying to deal with a moral hazard problem?

Accepted Answer

D

Question 2

The principal-agent problem arises because of

Accepted Answer

The principal-agent problem arises when the goals and interests of a principal (such as a shareholder or owner) differ from those of an agent (such as a manager or employee) who is supposed to act in the best interest of the principal. An example is when a manager prioritizes their own interests over the interests of shareholders. This conflict can lead to agency costs and inefficient outcomes.

Question 3

The field of behavioural economics builds a more subtle and complex model of economic behavior using insights from

Accepted Answer

Behavioural economics uses insights from the psychology of decision making to build a more nuanced model of economic behavior.

Question 4

The ultimatum game demonstrates that people will always make choices according to their self-interest.

Accepted Answer

The ultimatum game is an experimental game used in economics and psychology to study decision-making behavior. The game involves two players, one of whom (the proposer) is given a sum of money and must divide it with the other player (the responder). The responder can either accept or reject the proposer's offer. If the responder accepts, both players receive the amounts agreed upon. If the responder rejects, both players receive nothing. Studies have shown that people often reject unfair offers, even if it means receiving nothing, indicating a concern for fairness and not just self-interest.

Question 5

A person's tendency to smoke a cigarette after promising to quit is an example of the behavioral economics insight that people are inconsistent over time.

Accepted Answer

This response is based on the principle of time inconsistency in behavioral economics, which suggests that people may not always act in their long-term best interests, even if they have made a commitment to do so in the present. Therefore, a person's tendency to smoke after making a promise to quit can be seen as an example of this phenomenon.

Question 6

The principal-agent problem is more serious in large firms than in small firms because

Accepted Answer

Monitoring employee activity in large firms is generally more difficult than in small firms. Large firms have more employees, more departments and greater levels of specialization, which makes it harder to monitor employee activities effectively. This creates a greater potential for the principal-agent problem, where the interests of employees may not align with those of the firm's owners.

Question 7

Which of the following relationships involves asymmetric information?

Accepted Answer

Asymmetric information occurs when one party has more information than the other. In the case of the football game, the goalkeeper does not have information about where the penalty taker will shoot, whereas the penalty taker has information about where they plan to shoot. This creates asymmetric information between the two players. Options A, B, and C all involve situations where both parties have access to the same information, so there is no asymmetry.

Question 8

Alex, who knew nothing about construction, paid Stewart to build an extension on his house. Two years later, a wall of the new extension crumbled because Stewart used poor quality materials. This is an example of

Accepted Answer

This is an example of moral hazard, as Stewart did not have the incentive to use high quality materials due to the fact that he was paid upfront by Alex and had no liability for the quality of his work two years later. Adverse selection, screening, and signalling all refer to situations where one party has more information than another, which is not the case in this scenario.

Question 9

Since people tend to care about fairness, firms may give bonuses during particularly profitable years to be fair and to avoid retaliation from the workers.

Accepted Answer

Giving bonuses during profitable years is seen as a way for firms to be fair to their workers and to prevent potential retaliation for not sharing the profits.

Question 10

Asymmetric information is a problem that occurs when one person in a transaction knows more about what is going on than the other.

Accepted Answer

Asymmetric information refers to a situation where one party in a transaction has more information than the other party. This can create an imbalance of power and potentially lead to negative outcomes for the less informed party.

Question 11

To avoid the problem of adverse selection, insurance companies screen their prospective customers to discover hidden health problems.

Accepted Answer

This is true. Insurance companies screen their prospective customers to determine their risk level and discover any pre-existing conditions that could affect their health or potential insurance claims. This helps them to avoid adverse selection, where only high-risk individuals with pre-existing conditions purchase insurance.

Question 12

In the real world, people always behave rationally when making economic decisions.

Accepted Answer

In reality, people do not always behave rationally when making economic decisions. Factors such as emotions, biases, and limited information can all impact decision-making. This is known as bounded rationality.

Question 13

Which of the following relationships involves asymmetric information?

Accepted Answer

All of the relationships involve one party having more information than the other party, creating an imbalance of information or asymmetric information. The employee may have more information about their work effort than the employer. The borrower may have more information about their ability to repay the loan than the lender. The seller of a 30-year-old house may have more information about the condition of the house than the buyer.

Question 14

When one party is better informed about an economic situation than another party, economists describe the problem as one of

Accepted Answer

Asymmetric information refers to the situation where one party in a transaction has more or better information than the other party. This can lead to market inefficiencies and failures.

Question 15

In the principal-agent relationship, the principal performs a task on behalf of the agent.

Accepted Answer

In the principal-agent relationship, the agent performs a task on behalf of the principal. The principal hires the agent to act on their behalf and delegates authority to them to make decisions and take actions. The agent is expected to act in the best interest of the principal and follow their instructions.

Question 16

Employers may pay higher than equilibrium wages to avoid moral hazard in the employment relationship by raising the cost of shirking.

Accepted Answer

When employers pay higher than equilibrium wages, it creates a greater cost for employees who shirk or do not perform their job responsibilities. This acts as a deterrent against such behavior and reduces the risk of moral hazard in the employment relationship.

Question 17

Signals to convey high quality are most effective when they are costless to all firms in the industry.

Accepted Answer

Signals to convey high quality are most effective when they are costly or difficult to replicate, as they create a barrier for low-quality firms to imitate them. This can include investments in branding, certifications, or reputation-building activities. If the signal is costless to all firms, it may not effectively differentiate high-quality firms and may not be as credible to consumers.

Question 18

People seem to naturally engage in delayed gratification and they tend to follow through on plans made today to do something unpleasant in the future.

Accepted Answer

Research has shown that humans have a tendency towards instant gratification and may struggle with delaying gratification or following through on plans for future unpleasant events. However, individuals can learn and develop skills to improve their ability to delay gratification and stick to long-term plans.

Question 19

Moral hazard occurs when

Accepted Answer

Moral hazard refers to a situation where an agent, who is hired to act on behalf of a principal, has an incentive to pursue their own interests instead of the principal's interests, and the principal cannot observe the agent's actions. This creates a risk that the agent may take actions that are contrary to the principal's interests, thus leading to the possibility of losses for the principal. Examples of moral hazard include situations where insurance companies face the risk that policyholders will increase their exposure to risk (e.g., by engaging in reckless behavior) once they have obtained insurance coverage, and situations where managers may not work in the best interests of shareholders because they do not bear the full costs or benefits of their actions. Choice C best describes the situation where moral hazard occurs.

Question 20

The fact that someone with a high risk of medical problems is more likely to buy a lot of health insurance is an example of something that will give rise to

Accepted Answer

This scenario exemplifies adverse selection, where individuals with a higher risk of medical problems are more likely to seek out and purchase comprehensive health insurance, leading insurers to face an unequal distribution of costly claims.

Quiz 12: Information and Behavioural Economics

Which of the following would be an example of a principal trying to deal with a moral hazard problem?

The principal-agent problem arises because of

The field of behavioural economics builds a more subtle and complex model of economic behavior using insights from

The ultimatum game demonstrates that people will always make choices according to their self-interest.

A person's tendency to smoke a cigarette after promising to quit is an example of the behavioral economics insight that people are inconsistent over time.

The principal-agent problem is more serious in large firms than in small firms because

Which of the following relationships involves asymmetric information?

Alex, who knew nothing about construction, paid Stewart to build an extension on his house. Two years later, a wall of the new extension crumbled because Stewart used poor quality materials. This is an example of

Since people tend to care about fairness, firms may give bonuses during particularly profitable years to be fair and to avoid retaliation from the workers.

Asymmetric information is a problem that occurs when one person in a transaction knows more about what is going on than the other.

To avoid the problem of adverse selection, insurance companies screen their prospective customers to discover hidden health problems.

In the real world, people always behave rationally when making economic decisions.

Which of the following relationships involves asymmetric information?

When one party is better informed about an economic situation than another party, economists describe the problem as one of

In the principal-agent relationship, the principal performs a task on behalf of the agent.

Employers may pay higher than equilibrium wages to avoid moral hazard in the employment relationship by raising the cost of shirking.

Signals to convey high quality are most effective when they are costless to all firms in the industry.

People seem to naturally engage in delayed gratification and they tend to follow through on plans made today to do something unpleasant in the future.

Moral hazard occurs when

The fact that someone with a high risk of medical problems is more likely to buy a lot of health insurance is an example of something that will give rise to