Question 1

Bob is planning to sell his home. In preparation for the sale, he paints all of the ceilings in his house to cover up water stains from his leaking roof so that potential buyers will be unaware of this problem. This is an example of

Accepted Answer

The answer of Bob is planning to sell his home....

Question 2

Which of the following is not an example of signalling?

Accepted Answer

Screening is not an example of signalling. Signalling refers to actions or behaviors that convey information to others about one's qualities or characteristics. Screening involves the process of evaluating or selecting individuals based on certain criteria, but it does not necessarily involve the communication of information about one's qualities or characteristics. Advertising, getting an education, and gift giving can all be considered examples of signalling because they can convey information about one's abilities, achievements, or intentions.

Question 3

Which of the following is not a method firms use to avoid the moral hazard problem in the employment relationship? They:

Accepted Answer

Buying life insurance on workers is not a method to address moral hazard in employment; it is typically used for financial protection against the loss of a key employee.

Question 4

Markus is a travelling salesman for an insurance company. In this employment relationship, Markus is the

Accepted Answer

Markus is the agent in this relationship because he is the one selling insurance on behalf of the insurance company (the principal). A screener and signaller are not relevant roles in this context.

Question 5

Which of the following must be true about a signal that is used to reveal private information in order for the signal to be effective? It must be:

Accepted Answer

For a signal to be effective in revealing private information, it must be costly to the signalling party but less costly to the party with the higher-quality product. This is because if the signal is too easy or cheap to produce, both parties may use it, and it will not be an effective way to distinguish between products. If the signal is only used by the party with the superior product, it becomes a reliable indicator of quality.

Question 6

Moral hazard occurs when

Accepted Answer

Moral hazard arises when one party has the incentive to take risks because another party bears the cost of those risks. In an employment relationship, moral hazard occurs when the employee has more information than the employer about the actions being taken and the quality of the work being performed. The employee may take actions that benefit themselves at the expense of the employer, who may not be able to observe these actions. This lack of observation creates a situation in which an employee may shirk their responsibilities or engage in risky behavior without fear of repercussions. Therefore, choice (C) is the correct answer.

Question 7

Severe adverse-selection problems may result in

Accepted Answer

Severe adverse-selection problems in the used car market may result in too few good used cars being offered for sale. This is because sellers of good used cars may choose to keep their cars rather than sell them at a lower price to buyers who are more likely to be interested in lower quality used cars. This can lead to a decrease in the supply of good used cars and a higher overall price for used cars.

Question 8

Which of the following is an example of an adverse selection problem?

Accepted Answer

The man wanting to increase his life insurance coverage after his father has a heart attack is an example of adverse selection because he is more likely to have a higher risk of a heart attack due to a family history, making him a riskier candidate for the insurer. This means that the insurer may need to charge him a higher premium or deny coverage altogether, which is a problem caused by adverse selection. The other options do not involve information asymmetry or a higher risk for one party, so they are not examples of adverse selection.

Question 9

Frequently it is the case that: (1) A worker knows more than his employer about how much effort he puts into his job, and (2) the seller of a used car knows more than the buyer about the car's condition.

Accepted Answer

Both (1) and (2) serve as examples of asymmetric information because there is a difference in the information held by one party (the worker or seller) and the other (the employer or buyer), leading to an imbalance in the bargaining power of the parties involved. As a result, this can lead to issues such as adverse selection and moral hazard in the market.

Question 10

Which of the following offers an explanation as to why the principal-agent problem exists for a firm?

Accepted Answer

The principal-agent problem exists because the interests of the firm and the employees may not always align. The firm may want to maximize profit while employees may have different goals, such as working as little as possible to earn their paychecks. This misalignment creates a conflict where the firm cannot ensure that employees act in the best interests of the firm.

Question 11

Your friend works at a coffee shop on campus and regularly gives away free coffee to you and your friends when you visit. This is an example of

Accepted Answer

This is an example of a moral hazard problem as the friend may be giving away free coffee without considering the cost and potential negative impact on the business. The friend may also be more likely to give away free coffee to friends, which could lead to preferential treatment and potentially harm the overall fairness and efficiency of the business.

Question 12

A woman gives her boyfriend a birthday present. The gift could be viewed by the boyfriend as a

Accepted Answer

The gift can be viewed as a signal of how much she cares for him, as it shows that she has taken the time and effort to choose a gift that she believes he will like and that is meaningful to him. The other options, moral hazard problem and screening device, do not seem applicable in this situation.

Question 13

Rick goes to work 8 hours per day, but while he is at work he spends most of his time visiting internet sites monitoring his fantasy football teams. This is an example of

Accepted Answer

Moral hazard refers to a situation where one party takes risks because they know someone else will bear the cost of those risks. Hidden action refers to a situation where one party has more information or ability than another party, leading to opportunities for exploiting that advantage. In this case, Rick's behavior of spending most of his work hours monitoring his fantasy football teams constitutes hidden action as he is not fully utilizing his work hours, resulting in a cost to his employer. This behavior may also demonstrate moral hazard as he is taking the risk of misusing his company's time and resources because he anticipates that he will not be held accountable for his actions. Therefore, the correct answer is C - moral hazard and hidden action.

Question 14

Because people with hidden health problems are more likely to buy health insurance than are other people,

Accepted Answer

The fact that people with hidden health problems are more likely to buy health insurance implies that the insurance pool consists of a higher proportion of sick people. This leads to increased costs for the insurance provider, which is reflected in the price of health insurance. Thus, the price of health insurance reflects the costs of a sicker-than-average person.

Question 15

An apparel company employs Jean as a designer. In this employment relationship, the apparel company is the

Accepted Answer

The apparel company is the principal because they have hired Jean as their designer and have control over the work that Jean does. The principal in an employment relationship is the party that hires the other party to work on their behalf.

Question 16

Which of the following is an example of a signal that is used to reveal private information?

Accepted Answer

The answer of Which of the following is an example...

Question 17

John's car is in need of repair so John decides to sell it to avoid the repair bill. Unaware of the problem, Suzanne buys the car. This is an example of

Accepted Answer

This situation is an example of adverse selection, which is when one party in a transaction has more information than the other party and uses that information to their advantage. In this case, John knew about the problem with the car and didn't disclose it, while Suzanne was unaware and purchased the car. This leads to a negative outcome for Suzanne, who now has to pay for the necessary repairs.

Question 18

Which of the following best demonstrates the problem of moral hazard?

Accepted Answer

Moral hazard refers to the idea that individuals may take greater risks or act in a more reckless manner when they are protected from the consequences of their actions. In this case, Sally drives more recklessly after buying car insurance because she knows that the insurance company will cover the cost of any accidents or damage. This behavior represents moral hazard, as Sally is taking more risks than she otherwise would because of the insurance coverage. Choices A, B, and D do not demonstrate the problem of moral hazard.

Question 19

Effective signals

Accepted Answer

The answer of Effective signals
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Question 20

Nicole wants to avoid buying a car that is a lemon. She takes a car she would like to buy to her mechanic before she purchases it. This is known as

Accepted Answer

Screening refers to the process of gathering information about the quality of a product or service before making a purchase. In this case, Nicole is screening the car by taking it to her mechanic before buying it, in order to avoid buying a lemon. Signaling, moral hazard, and adverse selection all refer to different aspects of asymmetric information and are not relevant to this scenario.

Quiz 12: Information and Behavioural Economics