Question 1

Because in any period of time and in any region the quantity of pollutants that can be absorbed by nature is fixed, the supply of "pollution rights" in a cap-and-trade system will be perfectly elastic (horizontal).

Accepted Answer

The statement is false. While the supply of pollution rights may be predetermined, it is not necessarily perfectly elastic. The quantity of pollution rights available for trade could be restricted by regulations or other factors. Additionally, market demand for pollution rights will also affect the price and quantity traded, making the supply curve potentially upward sloping.

Question 2

If Congress decreases the amount of government insurance on bank deposits, then this action would

Accepted Answer

If Congress decreases the amount of government insurance on bank deposits, it would reduce the moral hazard problem in banking. With less government insurance, banks would have a greater incentive to be cautious and discriminate in their lending practices, which reduces the risk of moral hazard.

Question 3

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 insured individuals to take more risks or engage in more reckless behavior because they know they have insurance coverage. By imposing a deductible, the insured person has to bear some of the cost of any damages or losses, which may discourage them from engaging in risky behavior. Adverse selection refers to the tendency of higher-risk individuals to be more likely to purchase insurance, while externalities and public goods refer to other types of market failures.

Question 4

In the insurance business, the moral hazard problem arises when

Accepted Answer

The moral hazard problem in insurance refers to the phenomenon where individuals engage in riskier behavior or are less careful because they are insured. In this context, option C accurately describes a situation where people who have car insurance coverage might drive less carefully, knowing that any damages would be covered by their insurance.

Question 5

An effective antipollution policy from the economic perspective requires that all pollution be eliminated and banned.

Accepted Answer

Completely eliminating and banning all pollution is not feasible or realistic. Instead, effective policies aim to minimize and mitigate pollution while still allowing for economic growth and development. This can be achieved through regulations, taxes, incentives, and other market-based mechanisms that encourage firms to adopt cleaner technologies and practices.

Question 6

In a well-functioning cap-and-trade system for pollution rights, society benefits because pollution will be brought down to insignificant levels.

Accepted Answer

A well-functioning cap-and-trade system aims to reduce pollution to regulated levels, not necessarily to insignificant levels. The goal is to limit emissions to a level deemed acceptable by regulatory bodies, not eliminate them entirely.

Question 7

The franchising of fast-food restaurants would be an example of how a private business

Accepted Answer

Franchising allows for fast-food restaurants to expand their businesses without the need for additional capital or resources by partnering with interested individuals who operate their own franchises. This overcomes market information problems, as the franchiser has knowledge and expertise that the franchisee can leverage to create their own successful business.

Question 8

In dealing with market failures, the government always bases its decisions on economic analysis of marginal cost and marginal benefit.

Accepted Answer

While economic analysis of marginal cost and marginal benefit is an important tool, government decisions on dealing with market failures may also be influenced by political, social, and ethical considerations, not solely by economic analysis.

Question 9

Production subsidies are a way of internalizing external costs among polluting firms.

Accepted Answer

Production subsidies are a form of government intervention that provides financial assistance or tax relief to producers of goods or services. They are not a way of internalizing external costs among polluting firms, but rather can often perpetuate or encourage pollution by making it cheaper for firms to continue polluting. Internalizing external costs typically involves imposing fees or taxes on pollution to incentivize firms to reduce their emissions and account for the social and environmental costs of their actions.

Question 10

Which of the following would be an example of government intervention to correct a market failure caused by buyers having inadequate information about sellers?

Accepted Answer

Licensing of medical doctors and surgeons ensures that buyers (patients) have adequate information about the sellers (doctors) and their qualifications, thus correcting the market failure caused by asymmetric information. Option A (providing unemployment compensation insurance) is a social welfare program that addresses a different market failure (income inequality), Option B (sponsoring legislation to reduce pollution) addresses an externality and Option D (requiring all car drivers to buy auto insurance) is a regulatory policy related to risk management.

Question 11

In a well-functioning cap-and-trade system for pollution rights, the right to pollute will go to those who are able to acquire the largest net benefit from using the scarce resource "clean air."

Accepted Answer

This is true because in a cap-and-trade system, companies can buy and sell permits to emit a certain amount of pollution. Those who can reduce their emissions at a lower cost can sell their permits to those who find it more expensive to reduce their own emissions. This allows for market-based incentives to reduce overall pollution levels while still allowing businesses to operate and make a profit. The system allocates pollution rights to those who can use them efficiently, creating a net benefit for society as a whole.

Question 12

When sellers are unable to distinguish "good" buyers from "bad" ones, they face the problem of

Accepted Answer

Adverse selection occurs when sellers are unable to distinguish between "good" and "bad" buyers, leading to the possibility of selecting the wrong type of buyer and incurring losses.

Question 13

Which of the following does not illustrate the asymmetric information problem?

Accepted Answer

Ordinary stock buyers not knowing what will happen to the stock's price next week is not an example of the asymmetric information problem. This is simply uncertainty about future events, rather than a lack of information or information asymmetry between two parties. A, B, and D all illustrate situations where one party has more information than the other, leading to potential adverse selection or moral hazard.

Question 14

Which of the following would be an example of a moral hazard problem?

Accepted Answer

In option C, the person may feel less responsible for driving carefully or taking precautions because they are insured. This is an example of moral hazard, where insurance can actually incentivize riskier behavior.

Question 15

If a person drives with less care after purchasing auto insurance, this situation would be an example of a(n)

Accepted Answer

This situation is a moral hazard problem, as the person may feel less responsible for any damages or accidents after purchasing auto insurance and may drive more recklessly.

Question 16

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

Accepted Answer

Adverse selection occurs when individuals who are most likely to have unfavorable outcomes are the ones who choose to participate in a market. In this case, individuals who are most in need of insurance (and therefore more likely to have claims) are the ones most likely to purchase insurance, leading to adverse selection. The other options do not fit the definition of adverse selection.

Question 17

The 2010 Health Care Reform Law, also known as "Obamacare," includes a part known as universal coverage which requires everyone to have health insurance. One reason for this is to address the problem of

Accepted Answer

The requirement for everyone to have health insurance is meant to address the problem of adverse selection - the tendency for individuals with higher risk of needing medical care to be more likely to buy health insurance. Without a requirement for universal coverage, only those who are sicker or at higher risk would purchase health insurance, driving up costs for everyone. This requirement helps spread the risk and ensure that healthier individuals also purchase insurance.

Question 18

The "too big to fail" policy of the Fed, whereby some banks are bailed out if they are in danger of failing because they are too big and could bring the system down, leads to which of the following problems?

Accepted Answer

The "too big to fail" policy leads to moral hazard, as it incentivizes large banks to take on excessive risks knowing that the government will bail them out if they fail. This can lead to even greater financial instability in the long run.

Question 19

The Coase Theorem suggests that the government does not have to be involved at all in resolving a market failure due to externalities.

Accepted Answer

The Coase Theorem suggests that if property rights are well-defined and transaction costs are low, parties can negotiate and reach an efficient outcome on their own without government intervention. The government's involvement may still be necessary if transaction costs are high or property rights are not well-defined.

Question 20

Asymmetric information in a market transaction occurs when there is unequal knowledge possessed by the

Accepted Answer

Asymmetric information occurs when one party in a transaction has more or better information than the other party. In the context of a market transaction, it typically refers to the seller having more information than the buyer. Therefore, the best choice is (D), where the unequal knowledge is possessed by the buyer and the seller. The other options (A, B, and C) do not involve an exchange between a buyer and seller, so they cannot be the correct choices.

Quiz 4: Market Failures: Public Goods and Externalities