Question 1

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 about their customers.

Accepted Answer

The licensing and regulation of financial advisers are meant to ensure that advisers have the necessary qualifications and adhere to ethical standards, not to address information asymmetry about customers.

Question 2

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

Asymmetric information occurs when one party has more information than the other party, leading to an imbalance in bargaining power and potentially resulting in adverse selection or moral hazard.

Question 3

When the government bails out large banks when the banks become unstable, it could lead to a moral hazard problem.

Accepted Answer

Bailing out large banks could encourage them to take on more risks in the future, knowing that the government will rescue them if they falter. This can create a moral hazard problem, where banks behave recklessly because they know they won't bear the full consequences of their actions.

Question 4

E-bay 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

Both e-Bay and Amazon provide sellers' ratings based on the experiences of past buyers to help potential buyers make informed decisions and reduce the adverse selection problem.

Question 5

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. In the market for used cars, owners of poor-quality cars who know their cars are of low quality will have a strong incentive to sell their cars while owners of high-quality used cars who know their cars are of high quality will have more incentive to keep them. This results in a higher proportion of low-quality used cars on the market.

Question 6

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

Critics of unemployment insurance claim that some individuals may choose to not actively search for employment because they receive benefits that partially replace their lost income. This is known as the moral hazard problem, and is a common argument against providing government assistance to the unemployed.

Question 7

When the government bails out failing banks, it creates a moral hazard problem; but when the government bails out homeowners who are defaulting, there is no moral hazard problem.

Accepted Answer

Bailing out homeowners who are defaulting could also create a moral hazard problem where it incentivizes people to take out mortgages they cannot afford in the expectation that the government will bail them out in case of default.

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

The situation described in the scenario is an example of moral hazard. When depositors know that their deposits are insured by the federal government, they may not carefully check whether their bank is financially stable or not. This is because they are not worried about losing their money if the bank fails. As a result, the bank may take on more risk than it otherwise would have, knowing that it won't be punished for failure. This is a clear example of moral hazard.

Question 9

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 in a transaction has more information than the other party, leading to the less informed party being negatively impacted. In the case of insurance, those who are more likely to make insurance claims (such as those with pre-existing medical conditions) are more likely to seek out and purchase more comprehensive insurance policies, which can lead to higher costs for the insurer.

Question 10

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

Accepted Answer

The asymmetric-information problem in the used car market means that the seller may have more information about the quality of the car than the buyer. This can lead to a decline in the quality of the used cars in the market because sellers with low-quality cars are more likely to sell them to unsuspecting buyers who cannot fully assess the quality of the car. This can lead to a decrease in trust in the market and ultimately a decline in the quality of used cars.

Question 11

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 12

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 do provide information and ratings on businesses to help consumers make more informed decisions.

Question 13

E-bay, 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 are meant to help address adverse selection, which is the problem of buyers being unable to distinguish between high-quality and low-quality sellers in a market with imperfect information. By providing feedback from previous buyers, seller ratings can help buyers make more informed decisions and reduce the risk of purchasing from a low-quality seller. Externalities, moral hazard, and public goods are not directly addressed by seller ratings.

Question 14

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, which is the tendency of high-risk individuals to apply for and receive loans or insurance policies, while low-risk individuals choose not to. By providing credit histories, the credit bureaus help the banks and insurance companies better assess the risk associated with lending or insuring a particular individual. Public goods, externalities, and moral hazard are all different economic problems that are not directly addressed by credit bureaus providing credit histories.

Question 15

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.

Quiz 4: Market Failures: Public Goods and Externalities