Question 1

Insurance policies typically stipulate a deductible amount which the insured must shoulder; this is to address the problem of

Accepted Answer

The purpose of a deductible is to address the problem of moral hazard, which refers to the tendency of individuals to take risks or engage in behavior that they otherwise would not if they know they are protected by insurance. By requiring the insured to shoulder a portion of the cost through a deductible, they have a financial stake in avoiding losses or minimizing them. This helps to reduce the likelihood of excessive or unnecessary claims. Adverse selection, externalities, and public goods are not directly related to the use of deductibles in insurance policies.

Question 2

Depositors do not check their banks carefully for stability anymore, because of the Federal deposit insurance program.This illustrates the problem of

Accepted Answer

The situation described in the statement illustrates moral hazard. The existence of the Federal deposit insurance program eliminates the risk of losing money for depositors, which could lead them to believe that the bank is stable, even if it is not. As a result, they may no longer investigate or evaluate the bank's stability or soundness, which creates a moral hazard problem for the system.

Question 3

When critics of unemployment insurance claim that some of the unemployed are not exerting much effort to find jobs because of the unemployment benefits, they are referring to the moral hazard problem.

Accepted Answer

The concept of moral hazard refers to the tendency for people to take more risks or behave less carefully when they are protected from the consequences of those risks or behaviors. In the context of unemployment insurance, the moral hazard problem arises when unemployed individuals choose not to actively search for work or accept job offers because they are receiving benefits that partially offset their lost income.

Question 4

One consequence of the asymmetric-information problem in the used car market, if left unresolved, is the higher probability of

Accepted Answer

In the asymmetric-information problem in the used car market, sellers have more information about the quality of the car than the buyers. This leads to a situation where buyers are unsure about the quality of the used car they are buying and are therefore willing to pay a lower price. This, in turn, leads to sellers only selling lower-quality cars to avoid taking a loss. As a result, the overall quality of used cars in the market declines.

Question 5

eBay and Amazon provide "sellers' ratings" information based on the experiences of past buyers.This is to help resolve the adverse selection problem faced by potential buyers.

Accepted Answer

eBay and Amazon both provide sellers' ratings information to help potential buyers make informed decisions about purchasing from a particular seller. This information is based on the experiences of past buyers, and can help to reduce the adverse selection problem by providing buyers with information about the quality and reliability of different sellers.

Question 6

Credit bureaus provide credit histories to banks and insurance companies, in order to help deal with the problem of

Accepted Answer

Credit bureaus provide credit histories to banks and insurance companies in order to help deal with the problem of adverse selection, which refers to the tendency of those who are most likely to default on a loan or file a claim to be the ones who are most eager to obtain credit or insurance. By sharing information about an individual's creditworthiness, credit bureaus help lenders and insurers make more informed decisions about who to lend to or insure, which helps mitigate the risk of adverse selection.

Question 7

Asymmetric information occurs when the two parties in a market transaction do not have the same amount of information regarding the product or process involved in the transaction.

Accepted Answer

Asymmetric information occurs when one party has more information than the other party in a market transaction.

Question 8

A moral hazard problem occurs before a transaction-when people alter their behavior before they sign a contract, imposing costs on the other party.

Accepted Answer

A moral hazard problem occurs after a transaction or agreement has been made, when one party may change their behavior in a way that is disadvantageous to the other party because they do not bear the full consequences of their actions.

Question 9

When the government bails out large banks when the banks become unstable, it could lead to a moral hazard problem in banking.

Accepted Answer

Bailing out large banks creates an expectation that the government will intervene and protect them from any losses in the future, which may encourage risky behavior by those banks in the long run. This is known as the moral hazard problem in banking.

Question 10

Better Business Bureaus in various cities exist partly in order to try to deal with inadequate buyer information about sellers.

Accepted Answer

Better Business Bureaus aim to provide consumers with information about businesses to make informed decisions about buying from them.

Question 11

Adverse selection is when someone with home insurance decides to take the chance that a dying tree would fall on the garage, rather than spend the money to have the tree cut down.

Accepted Answer

Adverse selection refers to a situation where sellers have information that buyers do not, or vice versa, about some aspect of product quality. In the insurance context, it typically describes a scenario where individuals who are more likely to make a claim are also more likely to buy insurance, not the decision-making process of insured individuals regarding maintenance or risk management.

Question 12

Which of the following would be considered an example of adverse selection?

Accepted Answer

Adverse selection refers to the phenomenon where those who are most likely to need or use a particular service or product are the ones most likely to buy it. In this case, individuals who most need insurance may be more likely to purchase it, leading to adverse selection. The other options do not fit the definition of adverse selection.

Question 13

When the government bails out failing banks, it creates a moral hazard problem; but when the government bails out homeowners who are defaulting on their mortgages, there is no moral hazard problem.

Accepted Answer

Bailing out homeowners who are defaulting on their mortgages can create a moral hazard problem as it may encourage risky behavior in the future, such as taking on mortgages they cannot afford. It also leads to the issue of moral hazard as it may not differentiate between homeowners who were genuinely in need of assistance and those who simply took on too much debt.

Question 14

The licensing and regulation of financial advisers is one way by which the government tries to deal with the problem of inadequate information that financial firms have about their customers.

Accepted Answer

The answer of The licensing and regulation of financial advisers...

Question 15

An example of an adverse selection problem is in insurance, where the people most likely to claim insurance payouts are the people who will seek to buy the most generous policies.

Accepted Answer

Adverse selection occurs in insurance when individuals who are at a higher risk of making claims are more likely to purchase insurance policies with more generous coverage. This can lead to higher premiums for everyone in the insurance pool, as the insurer will need to compensate for the increased likelihood of payouts.

Quiz 4: Market Failures: Public Goods and Externalities