Question 1

Health insurance companies impose deductibles on policies and co-payments on claims

Accepted Answer

Health insurance companies impose deductibles and co-payments to reduce moral hazard problems. Moral hazard refers to the tendency of individuals to take more risks or seek more medical care when someone else is paying for it, leading to higher costs for the insurer. By requiring patients to pay a portion of the costs, they are less likely to overuse the insurance and more likely to make informed decisions about their healthcare.

Question 2

Consider a used car market in which half the cars are good and half are bad (lemons).A rational buyer in this market should

Accepted Answer

A rational buyer in this market should offer a price somewhere between the price she would pay for a good car and the price she would pay for a lemon. This is because the buyer cannot determine the quality of the car, and therefore, cannot make an informed decision regarding the value of the car. By offering a price in between the two extremes, the buyer is minimizing the risk of overpaying for a lemon or missing out on a good deal for a good car.

Question 3

Consider a used car market in which half the cars are good and half are bad (lemons).If buyers are rational,the prices being offered for used cars will result in

Accepted Answer

In a used car market with asymmetric information, buyers cannot distinguish between good cars and lemons. As a result, they offer a price that reflects the average quality. This leads to adverse selection, where sellers of good cars exit the market, leaving a larger proportion of lemons being sold.

Question 4

Most pharmaceutical firms selling prescription drugs continue to earn economic profits long after the patents on the prescription drugs expire because they have established a strong foothold in the market.

Accepted Answer

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Question 5

Due to adverse selection,very few lemons will be sold in the market for used cars.

Accepted Answer

Adverse selection implies that the market will be dominated by low-quality or inferior products, in this case, "lemons" or defective used cars. Therefore, a high number of lemons will be sold in the market, instead of few.

Question 6

When people who buy insurance change their behaviour after the purchase because they are protected from loss by the insurance,the insurance market is said to face the problem of

Accepted Answer

Moral hazard refers to the situation where individuals alter their behavior after they have been insured because they are protected from the loss. This behavior can lead to increased risks and losses for the insurer, which can ultimately lead to higher premiums for all policyholders. Adverse selection refers to the situation where individuals who are more likely to use the insurance are more likely to purchase it, leading to an unbalanced risk pool. Asymmetric information refers to the situation where one party has more information than the other, which can lead to one party benefiting at the expense of the other party. Economic irrationality is not a commonly recognized term in the insurance industry.

Question 7

The term that is used to refer to a situation in which one party to an economic transaction has less information than the other party is

Accepted Answer

The term used to refer to a situation in which one party to an economic transaction has less information than the other party is asymmetric information. Asymmetric information can lead to market inefficiencies and distortions of pricing, as one party may take advantage of the other's lack of information.

Question 8

Suppose that in a market for used cars,there are good used cars and bad used cars (lemons).Consumers are willing to pay as much as $6000 for a good used car but only $1000 for a lemon.Sellers of good used cars value their cars at $5000 each and sellers of lemons value their cars at $800 each.Buyers cannot tell if a used car is reliable or is a lemon.Based on this information,what is the likely outcome in the market for used cars?

Accepted Answer

In this market, buyers are willing to pay a maximum of $6,000 for a good used car, but sellers of good used cars are only valuing their cars at $5,000. This suggests that there is no profit to be made for sellers of good used cars, and they will likely drop out of the market. On the other hand, sellers of lemons are valuing their cars at $800, which is lower than the $1,000 that buyers are willing to pay. This suggests that there is a profit to be made for sellers of lemons, and they will likely remain in the market. As a result, the market will be dominated by sellers of lemons, and buyers will have a hard time finding reliable used cars.

Question 9

What is moral hazard?

Accepted Answer

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Question 10

In the highly competitive fast-food restaurant market,brand name restaurants have a strong profit incentive to maintain high sanitary conditions and avoid any negative consequences.

Accepted Answer

Brand name restaurants have a strong reputation to uphold and any negative consequence due to poor sanitary conditions can greatly impact their profitability and brand image. Therefore, they have a strong profit incentive to maintain high sanitary conditions.

Question 11

Consider a used car market in which half the cars are good and half are bad (lemons).Suppose the average price of a good car is $9000 and the average price of a lemon is $3000.If rational buyers are willing to pay $6000 for a used car,then sellers will agree to sell mostly the lemons at this price.What is the term used to describe this situation?

Accepted Answer

This situation is called adverse selection, where buyers face a lack of information about the quality of the products being sold, leading to a market dominated by low-quality (in this case, lemons) products. In this scenario, rational sellers are incentivized to sell their lemons at the same price as good cars, leading to buyers being unable to differentiate between the two and ultimately choosing the cheaper option. This results in the market being dominated by low-quality cars.

Question 12

Which of the following parties is likely to have the most information about the health of an individual who is trying to purchase a health insurance policy?

Accepted Answer

The individual who is applying for the health insurance policy is likely to have the most information about their own health, including medical history, pre-existing conditions, and current health status. Insurance companies may also request medical records from the individual's doctors, but the individual would still have more detailed and current information about their own health. The employer may have some information about the individual's health if they provide health insurance benefits, but it is likely to be limited. Option A is incorrect because the insurance company would only have access to the individual's medical history if the individual provides it. Option D is incorrect because information asymmetry exists in most markets, including the health insurance market.

Question 13

Advertising is the action of a firm that is intended to maintain the differentiation of its product over time.

Accepted Answer

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Question 14

A successful trademark is one that becomes a generic name for a product,for example,'Kleenex' has become a generic term for tissues.

Accepted Answer

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Question 15

If a state requires all drivers to purchase auto insurance,insurance companies still face the problem of

Accepted Answer

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Question 16

Adverse selection occurs in the market for used cars because used car buyers

Accepted Answer

Adverse selection occurs when one party in a transaction has more information than the other, which leads to an imbalance of information. In the market for used cars, buyers have less information than sellers about the true condition and history of the vehicle, which can lead to buyers being stuck with a lemon. This is why warranties, third-party inspections, and history reports have become increasingly popular in the used car market.

Question 17

The situation in which one party to a transaction takes advantage of knowing more than the other party to the transaction is known as asymmetric information.

Accepted Answer

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Question 18

One effect of adverse selection in a market is that the equilibrium quantity of the product may be smaller than it would have been if there were no information problems.

Accepted Answer

Adverse selection can lead to a situation where higher-quality goods are driven out of the market due to the prevalence of lower-quality goods, resulting in a smaller equilibrium quantity of the product. This is because buyers are hesitant to pay a premium for higher-quality goods if they are uncertain about the true quality of the product being offered. As a result, the market may not clear at the same quantity as it would have if there were no information problems.

Question 19

Automobile insurance companies have a problem with people who buy insurance and then drive recklessly or take less care to avoid losses after being insured.In other words,the automobile insurance market is subject to

Accepted Answer

Moral hazard occurs when one party, in this case, the insured, has an incentive to act in a way that increases the likelihood of a loss because they are insured against the consequences of that loss. This leads to the problem of reckless driving or taking less care to avoid losses, which can increase costs for insurance companies. Asymmetric information, market signaling, and adverse selection do not fully address this particular problem in the automobile insurance market.

Question 20

If a fire insurance company requires firms buying fire insurance to install automatic sprinkler systems,the insurance company is trying to reduce

Accepted Answer

The requirement for automatic sprinkler systems is an attempt to reduce the moral hazard problem, as it incentivizes firms to take steps to prevent fires from occurring or spreading.

Quiz 11: Monopolistic Competition and Oligopoly