Question 1

Susan buys automobile insurance from Provident Insurance Company. If Susan avoids having an accident for three years, Provident will reduce the premiums she has to pay for her insurance. Nevertheless, she routinely drives while eating or texting and speeds up to try to make it through yellow lights.
A) This is an adverse selection problem which should be corrected with government intervention.
B) Susan is a principal and Provident is an agent in this principal-agent problem.
C) This is a moral hazard problem.
D) There is no way for Provident to determine whether Susan is a cautious or risky driver.

Accepted Answer

This scenario describes a moral hazard problem where Susan has an incentive to engage in risky behavior because she knows she will still receive the insurance benefit if she avoids an accident for three years. Provident may need to monitor her behavior to prevent her from engaging in dangerous driving habits or increase her premiums to incentivize more cautious driving. Government intervention is not necessary in this case, as it is a private contract between Susan and Provident, and there is a way for Provident to determine Susan's driving behavior through monitoring or surveillance. The scenario does not involve a principal-agent problem as there is no indication that Provident is acting against Susan's interests.

Question 2

A college professor hires a student to babysit her children and pays the student an efficiency-wage. Which of the following is correct about the wage the student earns?
A) The wage is higher than the wage the student could earn working a similar job elsewhere.
B) The wage is the same as the wage the student could earn working a similar job elsewhere.
C) The wage is lower than the wage the student could earn working a similar job elsewhere.
D) The wage is likely to result in the student shirking responsibilities.

Accepted Answer

An efficiency-wage is a wage rate that is higher than the equilibrium wage rate in order to motivate workers to work harder and be more productive. Therefore, the wage the student earns is likely to be higher than what they could earn working a similar job elsewhere.

Question 3

Peter was recently hired as a salesman for a national consulting firm. His job involves spending a significant portion of his time out of the office visiting prospects and attending conferences. Which of the following is a strategy the consulting firm may employ to discourage Peter from shirking his responsibilities?
A) Tell Peter that the shareholders want to earn a large profit this year.
B) Pay Peter commissions on what he sells after the work has been completed.
C) Allow Peter to set his own schedule and work from home frequently.
D) Pay Peter a lower wage than he would earn in a similar job at another firm.

Accepted Answer

Paying Peter commissions on what he sells after the work has been completed is a strategy known as performance-based pay. By tying Peter's compensation to his sales, the consulting firm is incentivizing him to work hard and bring in more business. This is likely to discourage Peter from shirking his responsibilities because he knows that his income will decrease if he does not perform well. Option A is generic and unlikely to be a strong deterrent for Peter specifically. Option C might make Peter feel like he has a lot of freedom but it has no bearing on his performance. Option D is not a good strategy as it will not motivate Peter to perform well.

Question 4

Employers can try to overcome the moral-hazard problem involving their employees by
A) paying their employees more often.
B) paying their employees below-equilibrium wages since the employees will likely shirk some of their responsibilities.
C) better monitoring their employees' work efforts.
D) requiring their employees to take a pre-employment work effort test.

Accepted Answer

Option C, better monitoring their employees' work efforts, is the best choice to overcome the moral-hazard problem involving employees. By monitoring their employees' work efforts, employers can ensure that employees are working to their full capacity and not shirking their responsibilities. This reduces the chances of the employer suffering losses due to the employee's actions. Options A and D do not directly address the moral hazard problem, and option B is not a viable solution as it would lead to employee dissatisfaction and turnover.

Question 5

Employers may choose to pay their workers a wage that exceeds the equilibrium wage according to
A) efficiency-wage theories.
B) equilibrium wage theories.
C) screening theories.
D) signaling theories.

Accepted Answer

Efficiency-wage theories suggest that employers may choose to pay their workers a wage that exceeds the equilibrium wage in order to increase productivity and reduce turnover. By paying workers more than the market rate, employers can attract and retain higher quality workers who are more motivated to perform well on the job. This can lead to cost savings from lower turnover and higher productivity, which may offset the higher wage costs.

Question 6

Which of the following is a plausible explanation for a firm paying above-equilibrium wages to its workers?
A) It increases the probability that a worker who shirks will be caught.
B) It discourages workers from shirking out of fear of losing their high-paying job.
C) The Condorcet Paradox suggests that paying high wages will result in greater effort by employees.
D) By paying a high wage, employers solve this adverse selection problem and motivate the employees to work harder.

Accepted Answer

Paying above-equilibrium wages can discourage workers from shirking out of fear of losing their high-paying job.

Question 7

Kim owns a small business in Denver. She travels frequently, meeting with important customers, and attending conferences. Kim hired Matt to work in the Denver office as the day-to-day general manager of the business.
A) This is a moral hazard problem since Matt may not work as hard as Kim would like when he is not monitored.
B) Kim choosing to hire Matt is an example of adverse selection since it is possible that Matt will not work as hard as Kim expects.
C) Kim will most likely pay Matt a lower salary than normal since Kim will not be there to monitor Matt's work effort, and since Matt will not likely work hard knowing Kim cannot monitor his effort.
D) Kim is the agent and Matt is the principal.

Accepted Answer

The answer of Kim owns a small business in Denver....

Question 8

Peter was recently hired as a salesman for a national consulting firm. His job involves spending a significant portion of his time out of the office visiting prospects and attending conferences. Which of the following is a strategy the consulting firm may employ to discourage Peter from shirking his responsibilities?
A) Tell Peter that the shareholders want to earn a large profit this year.
B) Stop paying Peter bonuses based on how much he's sold.
C) Allow Peter to set his own schedule and work from home frequently.
D) Pay Peter an above-equilibrium wage.

Accepted Answer

The answer of Peter was recently hired as a salesman...

Question 9

When a night watchman only performs two walk-throughs per night when he is being paid to perform five walk- throughs per night, it is an example of
A) both moral hazard and adverse selection.
B) neither moral hazard nor adverse selection.
C) moral hazard, but not adverse selection.
D) adverse selection, but not moral hazard.

Accepted Answer

Moral hazard occurs when one party in a transaction has the opportunity to assume additional risks that negatively affect the other party because the latter cannot adequately monitor the former's behavior. In this case, the night watchman's failure to perform the agreed number of walk-throughs, due to the employer's inability to monitor every action, is a classic example of moral hazard. It is not an example of adverse selection, which refers to a situation where one party has more or better information than the other before the transaction occurs, leading to a poor selection of risks.

Question 10

You own an ice cream store and are concerned that an employee may be giving generous scoops to friends and relatives and smaller scoops to some other customers. This is an example of
A) a moral hazard problem.
B) adverse selection.
C) behavioral economics.
D) signaling.

Accepted Answer

This is a moral hazard problem as the employee has an incentive to behave in a way that benefits themselves (giving more ice cream to friends and family) at the expense of the store and other customers.

Question 11

Studies show that during the March Madness college basketball tournament, the productivity of the average company in the US falls considerably. This is an example of
A) the Condorcet Paradox.
B) signaling.
C) moral hazard.
D) screening.

Accepted Answer

The answer of Studies show that during the March Madness...

Question 12

An efficiency wage
A) gives an employee an incentive to shirk his duties.
B) is lower than the equilibrium wage for that position and region.
C) is higher than the equilibrium wage for that position and region.
D) both a and b are correct.

Accepted Answer

An efficiency wage is a wage that is higher than the equilibrium wage for that position and region. This is because the higher wage provides an incentive for employees to work harder, which can lead to increased productivity and decreased turnover. Option A is incorrect because the higher wage actually provides an incentive for employees to work harder rather than shirk their duties. Option B is also incorrect because the efficiency wage is higher than the equilibrium wage.

Question 13

In the case of a moral-hazard problem, which of the following is not a way for the principal to encourage the agent to act more responsibly? The principal could
A) better monitor the agent.
B) pay the agent above-equilibrium wages.
C) delay payment to the agent.
D) stop paying bonuses.

Accepted Answer

The answer of In the case of a moral-hazard problem,...

Question 14

Suppose you are covered under health insurance or belong to a Health Maintenance Organization (HMO), and you are insured against all or most of the costs of visits to the doctor. As a result you are likely to make greater use of medical services of all kinds. This tendency of people with insurance to change their behavior in a way that leads to more claims against the insurance company is called
A) adverse selection.
B) moral hazard.
C) screening
D) signaling.

Accepted Answer

The tendency described in the scenario is an example of moral hazard. Moral hazard refers to the situation where people with insurance change their behavior in a way that leads to increased claims against the insurance company because they no longer bear the full cost of their actions. Adverse selection occurs when people with a higher risk of needing medical care are more likely to buy insurance, while screening and signaling are both strategies used by insurers to separate high-risk from low-risk individuals. None of these concepts applies to the situation described in the scenario.

Question 15

Which of the following is not a common response to the moral hazard problem that employers face?
A) offering all employees some funding for additional education
B) paying efficiency wages
C) requiring employees to provide itemized receipts for reimbursable expenses
D) paying year-end bonuses rather than higher monthly earnings

Accepted Answer

The other options listed are common responses to the moral hazard problem, but offering all employees some funding for additional education may not necessarily address the issue of employee misconduct or shirking.

Question 16

You own an ice cream store and are concerned that an employee may be giving generous scoops to friends and relatives and smaller scoops to some other customers. This may be reducing sales. If you want your employee to stop giving larger scoops to friends and relatives, which of the following is not a good approach?
A) Make visits to the store at the same time each day.
B) Pay employees an above equilibrium wage.
C) Give your employees a monthly bonus based on profits.
D) None of the above are good approaches.

Accepted Answer

The answer of You own an ice cream store and...

Question 17

You own an ice cream store and are concerned that an employee may be giving generous scoops to friends and relatives and smaller scoops to some other customers. This may be reducing sales. In this example, you are the
A) principal and the your employee is the agent.
B) agent and the your employee is the principal.
C) signaler and the your employee is the screener.
D) screener and the owner of the coffee ship is the signaler.

Accepted Answer

The owner of the ice cream store is the principal and the employee is the agent. The principal-agent relationship means that the employee is acting on behalf of the owner and has a duty to act in the best interest of the owner. In this case, the employee is not acting in the best interest of the owner by giving larger scoops to friends and relatives and smaller scoops to some other customers, which may reduce sales.

Question 18

Steve borrowed some money from Summit Bank, telling the loan officer that he intended to use the money to remodel his restaurant. After getting the loan, Steve and his girlfriend immediately took the money and went gambling in Vegas.
A) This is an example of adverse selection since banks have difficulty selecting their customers.
B) This example does not involve asymmetric information.
C) From the given information, Steve is the principal and Summit Bank is the agent.
D) None of the above are correct.

Accepted Answer

The answer of Steve borrowed some money from Summit Bank,...

Question 19

Peter was recently hired as a salesman for a national consulting firm. His job involves spending a significant portion of his time out of the office visiting prospects and attending conferences. His firm is paying him a wage that is higher than the equilibrium wage, but he receives much of his income in quarterly bonuses based on how much he sells.
A) The consulting firm is trying to prevent adverse selection with its compensation strategy.
B) Peter has an incentive to go golfing with his buddies rather than conducting sales meetings.
C) The consulting firm is responding to the moral hazard problem with its compensation strategy.
D) Peter should quit this job and take a job where he gets paid an equilibrium wage more frequently.

Accepted Answer

The consulting firm is responding to the moral hazard problem by offering Peter a higher than equilibrium wage and bonuses based on sales. This is meant to incentivize him to put in the effort to make sales and not shirk his responsibilities while out of the office. The higher wage also serves as a deterrent to him leaving the job for a lower paying one where he may have less responsibility. Adverse selection and the potential for Peter to go golfing with his buddies are not addressed by this compensation strategy. There is no indication that Peter should quit his job for a lower paying one, as he may not be able to find a job that satisfies his preferences and meets his financial needs.

Question 20

A radio story reported a study on the makes and models of cars that were observed going through intersections in the Washington, D.C. area without stopping at the stop signs. According to the story, Volvos were heavily overrepresented; the fraction of cars running stop signs that were Volvos was much greater than the fraction of Volvos in the total population of cars in the D.C. area. This is initially surprising because Volvo has built a reputation as an especially safe car that appeals to sensible, safety-conscious drivers. How is this observation best explained?
A) Volvo drivers are not willing to take risks that they would take in another, less safe car. Driving a Volvo leads to a propensity to run stop signs.
B) Volvo drivers are not willing to take risks that they would take in another, less safe car. Driving a Volvo reduces the propensity to run stop signs.
C) Volvo drivers are willing to take risks that they would not take in another, less safe car. Driving a Volvo reduces the propensity to run stop signs.
D) Volvo drivers are willing to take risks that they would not take in another, less safe car. Driving a Volvo leads to a propensity to run stop signs.

Accepted Answer

This observation could be best explained by the possibility that Volvo drivers, feeling protected by the car's safety features, are more willing to take risks that they would not have taken in another less safe car, leading to a propensity to run stop signs.

Quiz 22: Frontiers of Microeconomics

A college professor hires a student to babysit her children and pays the student an efficiency-wage. Which of the following is correct about the wage the student earns?

Employers can try to overcome the moral-hazard problem involving their employees by

Employers may choose to pay their workers a wage that exceeds the equilibrium wage according to

Which of the following is a plausible explanation for a firm paying above-equilibrium wages to its workers?

Kim owns a small business in Denver. She travels frequently, meeting with important customers, and attending conferences. Kim hired Matt to work in the Denver office as the day-to-day general manager of the business.

When a night watchman only performs two walk-throughs per night when he is being paid to perform five walk- throughs per night, it is an example of

You own an ice cream store and are concerned that an employee may be giving generous scoops to friends and relatives and smaller scoops to some other customers. This is an example of

Studies show that during the March Madness college basketball tournament, the productivity of the average company in the US falls considerably. This is an example of

An efficiency wage

In the case of a moral-hazard problem, which of the following is not a way for the principal to encourage the agent to act more responsibly? The principal could

Which of the following is not a common response to the moral hazard problem that employers face?

You own an ice cream store and are concerned that an employee may be giving generous scoops to friends and relatives and smaller scoops to some other customers. This may be reducing sales. In this example, you are the

Steve borrowed some money from Summit Bank, telling the loan officer that he intended to use the money to remodel his restaurant. After getting the loan, Steve and his girlfriend immediately took the money and went gambling in Vegas.