Question 1

There is an adverse selection problem in the market for used cars because

Accepted Answer

Adverse selection occurs when one party in a transaction has more information than the other party, which leads to an imbalance of risk. In the market for used cars, owners of poor-quality cars are more likely to sell their cars because they know their cars are not worth as much as high-quality cars. On the other hand, owners of high-quality cars are more likely to keep their cars because they know their cars are worth more. This creates an imbalance of risk for buyers because they don't know if they are getting a high-quality car or a poor-quality car.

Question 2

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

Accepted Answer

In the used car market, the asymmetric-information problem can result in the seller having more information about the quality of the car than the buyer. This can lead to a decline in the overall quality of the used cars for sale, as buyers are more likely to purchase lower quality cars at a higher price due to their lack of information about the car's true condition. Therefore, choice B is the best option.

Question 3

eBay, Amazon, and other Internet shopping sites provide "seller ratings" done by previous buyers, in order to help deal with the problem of

Accepted Answer

Seller ratings on Internet shopping sites help to alleviate adverse selection in online transactions. Adverse selection is the problem of information asymmetry in which a buyer can't distinguish between high-quality and low-quality sellers. The seller rating system helps buyers to assess the reputation of sellers by allowing them to see the feedback and ratings given by other buyers who have already completed transactions with the seller.

Question 4

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

This statement accurately defines asymmetric information in market transactions.

Question 5

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 provide information and ratings on businesses to help consumers make informed decisions and address complaints. Their existence aims to improve buyer information and confidence in sellers.

Question 6

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" to help potential buyers make more informed decisions and reduce the adverse selection problem. These ratings are based on the experiences of past buyers and can help buyers determine whether a seller is trustworthy and reliable.

Question 7

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 moral hazard problem refers to the possibility that individuals may take more risks or behave differently because they do not bear the full consequences of their actions, such as not putting much effort into finding a job because they receive unemployment benefits.

Question 8

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

Accepted Answer

Moral hazard occurs when people take on more risks because they are protected from some or all of the consequences of their actions. In this case, depositors do not carefully check the stability of their banks because they know that they are protected by the Federal deposit insurance program. This program creates a moral hazard by encouraging depositors to take on more risk without fully considering the consequences.

Question 9

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 to help them deal with the problem of adverse selection. Adverse selection occurs when individuals with high risk of default are more likely to seek out and receive credit, leaving lenders with a pool of borrowers who are more likely to default on their loans. By providing lenders with information on an individual's credit history, the credit bureaus help lenders make more informed decisions and mitigate the risk of adverse selection.

Question 10

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 11

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 12

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

When the government bails out homeowners who default on their mortgages, it creates a moral hazard problem because it may incentivize future borrowers to take on risky mortgages with the expectation of being bailed out if they default.

Question 13

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 14

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 a sense of safety net for banks, leading to a moral hazard problem where banks may take excessive risks knowing that the government will bail them out if things go wrong. This can have negative consequences for the overall financial system.

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 refers to a situation where one party has more information than the other and uses it to their advantage. In the case of insurance, those who are most likely to make claims are the ones who will seek out the most generous policies, leading to an adverse selection problem for the insurer.

Quiz 4: Market Failures: Public Goods and Externalities