Question 1

_____ involves one party that takes advantage of information that a second party lacks when the second party is deciding what to buy or sell.

Accepted Answer

Adverse selection occurs when one party in a transaction has more or better information than the other party, typically leading to an imbalance in the transaction where the party with more information can take advantage of the situation. This is common in markets for goods like used cars or health insurance, where sellers or buyers possess information that the other party does not, potentially leading to a market failure.

Question 2

The U.S Federal Reserve (Fed) acts as a lender of last resort to commercial banks, meaning that that the Fed will bail out the banks when they encounter financial problems. It is often argued that this leads the banks to take on additional risks and therefore creates the problem of:

Accepted Answer

The Fed's role as a lender of last resort creates moral hazard, as banks may take on excessive risk knowing that they will be bailed out if they encounter financial problems.

Question 3

Which one of the following is NOT a remedy for moral hazard?

Accepted Answer

A subsidy does not address moral hazard; instead, it can potentially exacerbate it by lowering the cost of engaging in risky behavior. Copayments, coinsurance, and deductibles are all financial mechanisms designed to share risk and costs between the insurer and the insured, thereby reducing moral hazard by making the insured party bear a portion of the costs of their actions.

Question 4

A fixed amount of money that someone with insurance must pay each time the individual incurs a cost that is covered by insurance is called:

Accepted Answer

A copayment is a fixed amount paid by an insured person each time they receive a service covered by their insurance, distinguishing it from coinsurance (a percentage of costs), a deductible (a fixed amount paid before insurance coverage begins), and a subsidy (financial assistance to help pay for insurance).

Question 5

An amount that insurance customers must pay before their insurance starts covering costs is called _____, and it is used as a remedy for the _____ problem.

Accepted Answer

A deductible is an amount that insurance customers must pay before their insurance starts covering costs, and it is used as a remedy for the moral hazard problem, which occurs when individuals take more risks because they do not bear the full cost of those risks.

Question 6

Public goods are both:

Accepted Answer

Public goods are characterized by being nonrival (one person's consumption does not reduce the amount available for others) and nonexcludable (it is not possible to prevent anyone from using the good).

Question 7

Goods that are both rival and excludable are known as _____ goods.

Accepted Answer

Private goods are both rival (one person's consumption of the good reduces the amount available for others) and excludable (people can be prevented from using the good if they do not pay for it).

Question 8

National defense is an example of a service that is both:

Accepted Answer

National defense is an example of a nonrival and nonexcludable good, meaning that one person's consumption of national defense does not reduce its availability to others (nonrival), and it is not feasible to exclude anyone from its protection (nonexcludable).

Question 9

A national highway that requires its users to pay a toll is an example of a good that is both:

Accepted Answer

The answer of A national highway that requires its users...

Question 10

Because public goods are both nonrival and nonexcludable, it is possible for people to use these goods without having to pay for them. Enjoying the benefits of a good without paying for it is known as:

Accepted Answer

Free-riding occurs when individuals consume a good without paying for it, which is common with public goods due to their nonrival and nonexcludable nature.

Question 11

Which of the following is a solution to the free-riding problem of providing public goods?

Accepted Answer

Funding the provision of public goods through taxes is a common solution to the free-riding problem because it ensures that everyone contributes to the cost of the public good, regardless of their individual usage levels. This approach helps to overcome the issue where individuals might otherwise benefit from the good without contributing to its provision.

Question 12

Alice decides to lend $100 to someone, but it takes $200 to hire a lawyer to write a contract for the loan agreement. In this case, the lawyer's fee is an example of a:

Accepted Answer

The lawyer's fee is an example of a transaction cost, which refers to the expenses incurred in making an economic exchange, such as the cost of drafting a contract for a loan agreement.

Question 13

Karim wants to invest $100 in the stock market and does eight hours of research to decide which stock to buy. In this case, the value of Karim's time spent on doing the research will be an example of a:

Accepted Answer

The value of Karim's time spent on doing the research is an example of a transaction cost, which refers to the expenses incurred in making an economic exchange, including the time and effort invested in researching and finalizing the transaction.

Question 14

David lives in a farm that is 100 miles away from the nearest grocery store, so he must spend $25 in gas every time he goes grocery shopping. In this case, the cost of gas is an example of a _____ cost.

Accepted Answer

The cost of gas for David to go grocery shopping is a transaction cost, as it is an expense incurred in order to complete an exchange or transaction, in this case, the purchase of groceries.

Question 15

After a government introduces a new regulation, it must spend considerable resources to ensure compliance with that regulation. The resources spent toward ensuring the compliance is an example of _____ costs.

Accepted Answer

The resources spent by a government to ensure compliance with a new regulation are an example of transaction costs. Transaction costs are expenses incurred during the process of buying or selling a good or service, which in this context includes the costs associated with enforcing or ensuring compliance with regulations.

Question 16

The antitrust laws enacted by the federal government are aimed at preventing market failure arising from:

Accepted Answer

Antitrust laws are specifically designed to prevent market failures due to imperfect competition, such as monopolies or cartels, by promoting competition and regulating anti-competitive behavior.

Question 17

In an imperfectly competitive market, the market fails because the free-market equilibrium price is _____ than the socially optimal price, and the resulting quantity is _____ than the socially optimal quantity.

Accepted Answer

In an imperfectly competitive market, firms have some control over the prices they charge, often leading to higher prices than in a perfectly competitive market. This results in a quantity of goods produced and sold that is less than the socially optimal quantity, where social welfare (the sum of consumer and producer surplus) is maximized.

Question 18

New ideas and innovations by innovators are nonrival goods. That is, the same idea or innovation can be copied and used by several people without diminishing the original ones. Given this, do you think that the free market allocates resources toward innovation efficiently? If not, how does the government remedy this problem and encourage innovation in an economy?

Accepted Answer

The answer of New ideas and innovations by innovators are...

Question 19

For each of the following goods, state whether they are rival/nonrival and excludable/nonexcludable. Justify your answer in each case.
a. national defense
b. a personal laptop
c. streetlights
d. private parks

Accepted Answer

The answer of For each of the following goods, state...

Question 20

Plastic manufacturing is one of the most environmentally polluting production processes. Suppose that plastic is produced in a perfectly competitive market and that each unit of plastic produced creates a negative externality of $2.
a. Draw a supply and demand graph clearly marking the following:
1) marginal private benefit curve (assume that marginal social benefit and marginal private benefit are the same)
2) marginal private cost curve
3) marginal social cost curve
b) On the graph, mark the points that show the free-market equilibrium and the socially optimal level of price and quantity.
c) Mark the area of deadweight loss, and explain why the free-market equilibrium leads to a deadweight loss.
d) Provide one remedy for the negative externality associated with the production of plastic.

Accepted Answer

The answer of Plastic manufacturing is one of the most...

Quiz 12: Market Failure and Government Failure