Question 1

Because the federal government typically provides disaster relief to farmers, many farmers do not buy crop insurance even through it is federally subsidized. This illustrates

Accepted Answer

This situation demonstrates the moral hazard problem, as farmers are less likely to purchase crop insurance if they know that the government will provide disaster relief. They may take greater risks with their crops because they know they will be bailed out if something goes wrong.

Question 2

Product reviews help to alleviate problems associated with

Accepted Answer

Product reviews provide information to consumers about the quality, features, and performance of a product. This helps to alleviate the problem of asymmetric information, where one party (the seller) has more information about the product than the other party (the buyer).Reviews allow the buyer to make an informed decision and reduces the risk of purchasing a product that does not meet their expectations. Product reviews do not address moral hazard, positive externalities, or negative externalities.

Question 3

An improvement in the technology of pollution control is likely to increase society's optimal amount
of pollution abatement.

Accepted Answer

With better pollution control technology, it becomes more cost-effective to reduce pollution, potentially increasing the optimal level of abatement that society should aim for.

Question 4

Suppose a ﬁrm offers its workers a cafeteria plan in which it allows workers to allocate a set amount of fringe beneﬁt money toward speciﬁc insurance. Mary, who has ﬁve kids needing braces, selects
The family dental coverage. This is an example of the

Accepted Answer

The selection of a specific insurance by Mary, based on her particular needs (needing braces for her five children), represents adverse selection. Adverse selection occurs when one party to a transaction has more information than the other party and uses that information to their advantage. In this case, Mary has more information about her family's dental needs, and she used that information to choose the option that will benefit her the most. This can result in higher costs for the firm if many employees choose plans that benefit them individually rather than benefitting the group as a whole.

Question 5

Owners of defective used cars have more information about the condition of their vehicles than potential buyers of those used cars. This is an example of

Accepted Answer

This is because asymmetric information occurs when one party has more information than another party in a transaction, which is the case here where the owner knows more about the defect in the car than a potential buyer. The other options are not applicable in this scenario as there is no mention of moral hazard, spillover costs, or positive externalities in the given scenario.

Question 6

As it applies to insurance, the adverse selection problem is the tendency for

Accepted Answer

Adverse selection in insurance occurs when those who are most likely to file claims and receive payouts are the ones who are most likely to purchase insurance policies. This leads to an imbalance in the risk pool and can cause insurance companies to charge higher premiums to compensate for the increased likelihood of paying out claims.

Question 7

Buyers will opt out of markets in which

Accepted Answer

Buyers are likely to opt out of markets where there is inadequate information about sellers and their products, as this increases the risk and uncertainty associated with purchasing decisions.

Question 8

Where there is asymmetric information between buyers and sellers,

Accepted Answer

Whenever there is an asymmetric information between buyers and sellers, markets can produce inefficient outcomes because the uninformed party may end up making choices that they would not have made if they had information, leading to market failure.

Question 9

Suppose an insurance company decided to offer divorce insurance. Based on the concept of moral hazard, economists would expect

Accepted Answer

Economists would expect mostly the couples with marital problems to purchase divorce insurance due to moral hazard. Moral hazard refers to the idea that individuals may take greater risks or engage in more risky behaviors because they are protected by insurance. In the case of divorce insurance, some couples may be more likely to engage in behaviors that increase the likelihood of divorce because they believe they are protected financially. Therefore, it is more likely that couples experiencing marital problems would purchase divorce insurance, while couples without problems may not see the need.

Question 10

In response to the 2008 ﬁnancial crisis, the government began to bail out banks deemed "too big to fail." Critics of this action argued that this would create the prospect of future bailouts and
Encourage banks to be ﬁscally irresponsible in the future. This illustrates

Accepted Answer

The moral hazard problem refers to the tendency of people or businesses to take on more risk when they are insured against that risk. In this case, the government's action of bailing out banks that were considered "too big to fail" created the moral hazard of encouraging banks to take risks in the future because they knew that they could be bailed out again if things went wrong.

Question 11

Society's marginal cost of pollution abatement curve slopes upward because of the law of
diminishing marginal utility.

Accepted Answer

The marginal cost of pollution abatement curve slopes upward due to the law of increasing marginal costs, not diminishing marginal utility. This reflects that as more pollution is abated, the cost of reducing additional units of pollution increases.

Question 12

(Consider This) The principle that private negotiation can resolve potential externalities without
resorting to government intervention is known as the Coase theorem.

Accepted Answer

The statement provided is true. The Coase theorem states that private negotiation can resolve potential externalities without government intervention, as long as property rights are clearly defined and transaction costs are low.

Question 13

Upon learning that his auto transmission is about to fail, Ray sells his car to an unsuspecting buyer. This circumstance illustrates the

Accepted Answer

Adverse selection occurs when one party in a transaction has more information than the other, particularly in situations where the party with more information uses it to their advantage. In this case, Ray knows about the failing auto transmission but does not disclose this information to the buyer, leading to adverse selection.

Question 14

TripAdvisor provides online reviews of hotels, restaurants, and attractions at tourist destinations around the world. When a traveler is planning a vacation, TripAdvisor helps the traveler avoid

Accepted Answer

TripAdvisor helps travelers avoid adverse selection by providing a platform for previous guests to share their experiences and opinions about hotels, restaurants, and attractions. Travelers can use this information to make informed decisions about where to stay and what to do, thereby avoiding the risk of selecting a subpar option.

Question 15

As it applies to insurance, the moral hazard problem is the tendency for

Accepted Answer

The moral hazard problem in insurance refers to the risk that policyholders may take less precaution in avoiding the insured risk since they know they are protected by insurance. This can lead to an increase in claims and higher premiums for all policyholders. Therefore, option B is the best choice. Options A, C, and D are unrelated to the moral hazard problem in insurance.

Question 16

Upon buying a car with airbags, Indy begins to drive recklessly. This is an example of the

Accepted Answer

The moral hazard problem arises when an individual takes more risks or engages in reckless behavior due to the protection of insurance or safety measures, such as airbags in this case. Indy's reckless driving behavior after buying a car with airbags is an example of moral hazard. The principal-agent problem is a situation where an agent (such as an employee) may act in their own interest rather than the best interest of the principal (such as the employer). Adverse selection refers to the phenomenon where individuals with higher-risk activities are more likely to purchase insurance than those with lower-risk activities, leading to higher premiums for everyone. The free-rider problem is a situation where individuals benefit from a public good without paying for it, such as enjoying a park without contributing to its maintenance. None of the other options accurately describe Indy's behavior in this scenario.

Question 17

Sellers will opt out of markets in which

Accepted Answer

When information about buyers is inadequate, sellers cannot gauge the true intentions of buyers and may fall prey to buyers who might impose high costs on them. This may result in sellers opting out of such markets.

Question 18

Professional buyers of antiques often have more information about the value of antique objects than do the sellers. This illustrates

Accepted Answer

The situation described in the statement is an example of asymmetric information, where one party (the professional buyers) has more information about the value of the antique objects than the other party (the sellers). Asymmetric information can create challenges in transactions and negotiations between parties, as one party may have an advantage over the other due to their superior information.

Question 19

Some sellers of used cars provide warranties to buyers, with the aim of reassuring buyers that the car is of good quality. These warranties help reduce the chance of what occurring?

Accepted Answer

Warranties help reduce the chance of adverse selection, where buyers may assume that the seller is trying to sell a low-quality car and only those with issues will be sold. This reduces the risk to the buyer and increases the likelihood of a fair transaction.

Question 20

In a television advertisement for AFLAC supplemental health insurance, an ice skater says to his skating partner, "Do you want to try a triple jump?" She responds, "Why not, I have AFLAC." This
Response illustrates the

Accepted Answer

The response of the ice skater's partner indicates that she is willing to take a riskier action (trying a triple jump) because she feels protected by her AFLAC supplemental health insurance. This is an example of moral hazard, where individuals may take greater risks or be more careless in their behavior when they are insured because they feel protected from the consequences of their actions.

Quiz 4: Market Failures Caused by Externalities Asymmetric Information