Question 1

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 more or better information than the other party, typically leading to a selection of poorer-quality goods or risks. Moral hazard happens when one party takes on more risk because they know the other party bears the consequences. Both are issues that arise due to asymmetric information, where one party has more or better information than the other.

Question 2

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 occurs when a person takes more risks because they know they are protected, in this case, by full auto insurance, leading to less cautious behavior like not using an alarm or locking the car.

Question 3

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

Moral hazard refers to the situation where one party in a contract takes on more risks because they know that the other party bears the costs of those risks, leading to a change in behavior that can disadvantage the other party.

Question 4

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 because one party may take more risks or act less carefully knowing they are protected, thus potentially harming the other party involved in the contract.

Question 5

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

Accepted Answer

Both moral hazard and adverse selection are significant issues in the insurance industry. Adverse selection occurs when there is asymmetric information before the transaction, leading to higher-risk individuals being more likely to purchase insurance. Moral hazard happens when the behavior of the insured party changes in a way that raises risks after the policy is purchased, due to the security the insurance provides.

Question 6

________ is (are) used to distinguish between high and low quality and help correct the adverse selection problem.
A) Asymmetric information
B) Payoffs
C) Moral hazard
D) Market signals

Accepted Answer

Market signals are used to distinguish between high and low quality and help correct the adverse selection problem by providing information that can help parties in a transaction make better-informed decisions.

Question 7

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 where one party takes more risks because they know they won't bear the full consequences of their actions, not to the issue of high-quality goods or consumers being squeezed out due to asymmetric information. The latter describes the concept of adverse selection.

Question 8

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 9

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

Accepted Answer

Both adverse selection and moral hazard are significant issues in the insurance industry. Adverse selection occurs when there is asymmetric information before the transaction, leading to higher-risk individuals being more likely to purchase insurance. Moral hazard happens post-contract, where the insured's behavior changes in a way that may increase the likelihood of a claim because they bear less risk.

Question 10

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 11

Relating to the Economics in Practice on page 362: 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 allows skiers to share weather conditions with others, acting as a form of market signaling. This is because it provides valuable information to the market (in this case, other skiers) about the current conditions, helping them make informed decisions.

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

Moral hazard occurs when one party in a contract alters their behavior after the contract is signed in a way that passes risks or costs to the other party, often because they are insulated from the consequences of their actions by the contract itself.

Question 13

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

Taking a babysitting course from the Red Cross serves as a market signal because it communicates to potential clients that Annie has a certain level of training and expertise, differentiating her from other babysitters who may not have such qualifications.

Question 14

Related to the Economics in Practice on page 360: 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 specifically mentions that the lanai overlooks the pool, which implies that the primary view from the condo is of the pool. This does not necessarily mean it has no other views, but the emphasis on the pool view suggests that other desirable views (like ocean, mountain, or city views) may not be prominent or available.

Question 15

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 16

Refer to the Economics in Practice on page 360. Advertisements provide information in two ways-what they say and what they omit.

Accepted Answer

Advertisements provide information both through the content they explicitly present and through the information they choose not to include, influencing consumer perception and decision-making.

Question 17

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 18

Related to the Economics in Practice on page 359: The individual mandate feature of the Affordable Care Act potentially broadens the pool of people who are in the health insurance market. Including young, healthy people in this pool via the mandate should potentially reduce ________ and ________ overall health care costs.
A) adverse selection ; raise
B) asymmetric information; raise
C) adverse selection; lower
D) asymmetric information; have no impact on

Accepted Answer

The individual mandate of the Affordable Care Act aims to include more young, healthy individuals in the health insurance market, which can reduce adverse selection (where insurers cannot accurately price risk due to information asymmetry, leading to a pool of higher-risk individuals) and lower overall healthcare costs by spreading the risk across a healthier population.

Question 19

Relating to the Economics in Practice on page 357: 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 is an example of adverse selection, where individuals with private information about their high risk of needing long-term care are more likely to purchase insurance, potentially leading to imbalances in the insurance market.

Question 20

Relating to the Economics in Practice on page 357: 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...

Quiz 17: Uncertainty and Asymmetric Information