Question 1

By requiring that applicants for insurance policies fill out lengthy forms and take a physical examination, insurers attempt to guard against

Accepted Answer

Insurers require lengthy forms and physical examinations to guard against adverse selection. Adverse selection occurs when individuals who are more likely to make claims purchase insurance, leading to an imbalance in the risk pool and higher costs for the insurer. By screening applicants, insurers can identify and charge higher premiums to those who are more likely to make claims.

Question 2

The tendency for the poorest risks to buy health insurance and the tendency of the insured to take more risks with their health are known as moral hazard and adverse selection, respectively.

Accepted Answer

Adverse selection refers to the tendency for the poorest risks to buy health insurance, while moral hazard refers to the tendency of the insured to take more risks with their health.

Question 3

By requiring that policyholders pay a deductible on a claim, insurers guard against

Accepted Answer

By requiring a deductible, insurers can discourage policyholders from filing small or frivolous claims, which can be a form of moral hazard where a person may not take sufficient care to protect against damages because they know they will not bear the full cost of any losses.

Question 4

The adverse selection problem is most likely in which of the following occupations?

Accepted Answer

The adverse selection problem is more likely to occur in occupations where the quality of the service cannot be easily observed by the customers, such as in the case of college professors. In contrast, in occupations like waiter/waitress or supermarket cashier, the quality of the service can be easily observed by the customers, reducing the likelihood of adverse selection. Barber and tightrope walker are not good or relevant options for this question.

Question 5

Suppose Sally buys a Volvo because they are safe and, as a result, drives faster and pays less attention to other cars on the road.This is an example of

Accepted Answer

This is an example of moral hazard where the purchase of a safer car leads to riskier behavior because the driver feels more protected.

Question 6

Adverse selection is more likely when

Accepted Answer

Adverse selection occurs when one party has better information than the other party. In the case of a job requiring intangible or unmeasurable abilities, the employer may not have complete information about the employee's qualifications and may therefore experience adverse selection. This is because the employee may be able to exaggerate their abilities or qualifications, which can lead to a mismatch between the employer's expectations and the employee's actual abilities.

Question 7

An example of a moral hazard would be Andrew leaving the washer, dryer, and dishwasher running at home while he goes to class since he is fully insured and he will not be at risk if a fire occurs.

Accepted Answer

This is an example of moral hazard because Andrew is not taking necessary precautions to prevent a potential loss or damage since he is fully insured and does not face any personal financial consequences if a fire occurs.

Question 8

There is less of a principal-agent problem between managers and apple pickers than between managers and secretaries because

Accepted Answer

Productivity is easier to measure in apple picking than in secretarial services. This means that it is easier for managers to evaluate the work of apple pickers and ensure they are working efficiently, reducing the principal-agent problem. Secretarial work is often less tangible and harder to measure, leading to a greater potential for the principal-agent problem to arise.

Question 9

Adverse selection refers to a situation in which

Accepted Answer

Adverse selection occurs when one party in a transaction has more information than the other, leading to a potential imbalance. In this context, it refers to job candidates having more information about their own abilities than employers do.

Question 10

Waiters, barbers, and bellhops are paid primarily through tips because

Accepted Answer

Consumers are able to judge the quality of service provided by waiters, barbers, and bellhops based on their personal experiences with them. Therefore, it makes sense for these service workers to be paid primarily through tips, as it incentivizes them to provide high-quality service in order to earn more money.

Question 11

When applying for a loan, a borrower tends to know more about her ability to pay it back than does the bank.This is an example of

Accepted Answer

Asymmetric information refers to a situation where one party in a transaction has more or better information than the other party. In this case, the borrower has more information about her ability to pay back the loan than the bank does, which puts the bank at a disadvantage and increases the risk of the borrower defaulting on the loan.

Question 12

Insurance companies try to avoid adverse selection and moral hazard problems through all of the following methods except one.Which is the exception?

Accepted Answer

Setting uniform premiums for all policies does not address adverse selection or moral hazard as it does not take into account the varying risks and behaviors of individuals. The other options - offering group policies, requiring lengthy application forms, requiring physical examinations, and requiring policyholders to pay a deductible - are all methods used by insurance companies to mitigate adverse selection and moral hazard problems.

Question 13

Savers have less incentive to care what their bank is doing with their money because their deposits are federally insured.This is a problem of

Accepted Answer

Moral hazard refers to the tendency of people to take more risks or act less responsibly when they are protected from the negative consequences of their actions. In the context of banking, federal deposit insurance can create a moral hazard problem because depositors may be less vigilant about monitoring their bank's behavior and safety, knowing that the government will step in to protect their deposits if the bank fails. This can lead to banks taking on excessive risk or engaging in other behavior that is not in the best interest of their depositors.

Question 14

Lemon laws are an attempt to reduce __________ in used car markets.

Accepted Answer

Lemon laws aim to reduce adverse selection, which occurs when sellers have more information about the quality of a product than buyers, leading to the market being flooded with low-quality products (lemons).

Question 15

Which of the following is not an example of moral hazard?

Accepted Answer

Giving more to charity just because it is tax deductible is not an example of moral hazard. Moral hazard refers to the situation where one party takes greater risks because another party bears the cost or consequences of those risks. Tax deductibility does not create this situation.

Question 16

The tendency for the poorest risks to buy health insurance and the tendency of the insured to take more risks with their health are known as

Accepted Answer

Adverse selection refers to the tendency of the insured to take more risks with their health, whereas moral hazard refers to the tendency for the poorest risks to buy health insurance. Therefore, choice D is the correct answer. The other options either mix up the concepts or do not accurately describe either adverse selection or moral hazard.

Question 17

At Tony's Car Wash, a team of four workers washes and rinses each car by hand, and one worker dries the car by hand.Which of the following is true?

Accepted Answer

When multiple workers are involved in a task, like washing and rinsing, it is harder to monitor individual performance, leading to more principal-agent problems compared to a single worker drying the car.

Question 18

The adverse selection problem is least likely in which of the following occupations?

Accepted Answer

Adverse selection is a problem that occurs when an individual or a company has asymmetric information, which means that they know more than the other party about a particular situation. This can lead to one party making an unfavorable decision, which can be costly. In the case of a barber, there is less informational asymmetry, as the quality of the service can be actively seen during the haircut. Therefore, adverse selection is less likely to occur.

Question 19

If an employment situation is characterized by adverse selection, there is an excess supply of underqualified applicants for each job.

Accepted Answer

Adverse selection occurs when there is asymmetric information between employers and applicants, leading to a situation where employers cannot distinguish between qualified and underqualified candidates, resulting in an excess supply of underqualified applicants.

Question 20

Moral hazard occurs when a person's behavior changes in a way that

Accepted Answer

Moral hazard refers to the situation where a person changes their behavior because they are not fully responsible for the consequences of their actions. This can lead to an increase in the chances of an unfavorable outcome, as the person may take more risks or be less careful in their actions, knowing that they will not bear the full cost of any negative consequences.

Quiz 14: Transaction Costs, Imperfect Information, and Behavioral Economics