Question 1

Because education is less costly to obtain for highly productive individuals who are also likely to be highly productive in the work place, education ________ in the job market.

Accepted Answer

Education is a strong market signal in the job market because it indicates that an individual is highly productive and has skills that are valuable to employers. Since education is less costly for those who are already highly productive, it serves as a reliable indication of a person's potential for success in the workplace.

Question 2

If ________ enters into an exchange with another party who has ________ information, there is asymmetric information and adverse selection.

Accepted Answer

Asymmetric information and adverse selection occur when one party in an exchange has more information than the other party. This can happen with both buyers and sellers and is best represented by choice B where one of the parties in the exchange has more information than the other.

Question 3

Which of the following statements about asymmetric information is true?

Accepted Answer

Asymmetric information occurs when one party to a transaction has relevant information to the transaction that the other party does not have. It is a common problem in many markets and can lead to market failures. While government intervention may be one solution, there are also other ways to address the issue, such as developing reputation systems or providing more information to consumers. Asymmetric information can occur in many markets, not just used cars and insurance.

Question 4

An automobile finance company faces an adverse selection problem if borrowers

Accepted Answer

If borrowers with a greater chance of defaulting on their car loans get loans from the lender, it can lead to higher default rates and financial losses for the company. This is because such borrowers may have a history of poor credit, a low income, or other factors that increase their risk of default. To address this adverse selection, the finance company may need to screen applicants more carefully, offer higher interest rates or collateral requirements, or create different loan products for high-risk borrowers.

Question 5

You cause a fire insurance company to face a moral hazard problem when you take ________ you buy fire insurance from the company.

Accepted Answer

By taking fewer precautions to prevent fires after buying fire insurance, the policyholder is more likely to file a claim for damages in case of a fire, which increases the likelihood of the insurance company having to make a payout. This creates a moral hazard problem for the insurance company, as the policyholder's lack of care may increase the overall risk of fire and the costs incurred by the insurance company.

Question 6

As a result, of adverse selection problems in the fire insurance market, it is likely that over time

Accepted Answer

Adverse selection in the fire insurance market leads to a situation where insurers find it difficult to distinguish between high-risk and low-risk customers. Consequently, they might set premiums that are too high for low-risk individuals, discouraging them from buying insurance. This results in a higher proportion of high-risk individuals in the insured pool, making it less likely for low-risk individuals to be insured.

Question 7

Buyers and sellers use ________ to communicate the quality of goods and services in a world of uncertainty.

Accepted Answer

Market signals are utilized by buyers and sellers to communicate with each other about the quality of goods and services in a world of uncertainty. Market signals are indicators that convey information about a given product or service's desirability, quality, and price. Asymmetric information, expected value, and moral hazard are also relevant concepts in economics, but they are not directly related to the communication of quality between buyers and sellers.

Question 8

Which of the following are examples of tools used to reduce adverse selection?

Accepted Answer

All three options (universal health coverage, dealer warranties, and lemon laws) are tools used to reduce adverse selection.

Universal health coverage ensures that everyone has access to health care, thereby reducing adverse selection among those who would otherwise avoid purchasing health insurance until they become sick or injured.

Dealer warranties provide assurance to buyers that the product they are buying is of a certain quality and will not break down easily, thereby reducing adverse selection by separating high-quality products from low-quality ones.

Lemon laws protect buyers of defective products from being stuck with a lemon, which could otherwise have been deliberately sold by the seller to an unsuspecting customer. This reduces adverse selection by ensuring that only high-quality products are offered for sale.

Question 9

Related to the Economics in Practice on page 356: Insurance companies are interested in being legally allowed to obtain the results of genetic testing before deciding on issuing insurance policies to potential buyers, which would lessen the problem of ________ in the health insurance market.

Accepted Answer

Adverse selection is the tendency of those in the worst health conditions to be more likely to purchase insurance, leading to an imbalance of risk for insurance companies. If insurance companies were allowed to obtain the results of genetic testing, they would be able to more accurately assess the risk of potential buyers and adjust premiums accordingly, reducing the problem of adverse selection. Moral hazard refers to the tendency for insured individuals to take more risks because they are covered by insurance. Market signaling refers to the use of certain actions or characteristics to signal information to the market about one's level of risk. Risk-loving refers to an individual's willingness to take risks.

Question 10

Warranties, education, extracurricular activities are all examples of

Accepted Answer

The answer of Warranties, education, extracurricular activities are all examples...

Question 11

In the market for used electric wheelchairs, there are high- and low-quality wheelchairs. Potential buyers cannot determine prior to purchase whether a wheelchair is high or low quality. The following statement that best describes what is likely to happen in this market is

Accepted Answer

This scenario is an example of adverse selection, as the buyer cannot determine prior to purchase whether a wheelchair is high or low quality. Therefore, the price of a used wheelchair is likely to be between the buyer and seller values for low-quality wheelchairs. This will encourage people to withdraw high-quality wheelchairs from the market.

Question 12

You are in the market for a used 2013 Toyota Corolla. You know that half of the 2013 Corollas are lemons and half are peaches. If you could be assured that the Corolla you were buying was a peach, you would be willing to pay up to $12,000. On the other hand, you would only be willing to pay $4,000 for a lemon. You have no ability to discern whether any particular Corolla is a lemon or a peach. Sellers of Corollas, on the other hand, are likely to know whether their particular car is a lemon or a peach. Suppose sellers of lemons will sell their cars for $3,000 or more and peach sellers will be willing to sell their cars for $9,000 or more. If you are risk neutral, you are willing to offer ________ and ________ are willing to sell you their car.

Accepted Answer

The answer of You are in the market for a...

Question 13

Relating to the Economics in Practice on page 356: An individual with a parent who has Huntington's disease has a 50 percent chance of also having the disease, and can use this information when deciding on the purchase of health insurance. This is an example of ________ favoring potential insurance buyers.

Accepted Answer

Asymmetric information occurs when one party in a transaction has more or better information than the other, such as an individual knowing their genetic risk for a disease when purchasing health insurance.

Question 14

You are in the market for a used 2013 Toyota Corolla. You know that half of the 2013 Corollas are lemons and half are peaches. If you could be assured that the Corolla you were buying was a peach, you would be willing to pay up to $12,000. On the other hand, you would only be willing to pay $4,000 for a lemon. You have no ability to discern whether any particular Corolla is a lemon or a peach. Sellers of Corollas, on the other hand, are likely to know whether their particular car is a lemon or a peach. Suppose sellers of lemons will sell their cars for $3,000 or more and peach sellers will be willing to sell their cars for $9,000 or more. Over time the price in the market for 2013 Corollas will

Accepted Answer

Since buyers cannot distinguish between lemons and peaches, they will only be willing to pay an average price. Sellers of peaches will not sell at this lower price, leaving only lemons in the market.

Question 15

Relating to the Economics in Practice on page 360: The smart phone app which allows skiers at a slope to report weather conditions to others would lessen the problem of

Accepted Answer

The app would lessen the problem of asymmetric information, as it allows skiers to share information about weather conditions with others, reducing the information asymmetry and potential for adverse selection.

Question 16

A credit union faces a(n) ________ problem when it lends funds to a customer to remodel her home and the customer then opportunistically uses the funds for a gambling trip to Las Vegas.

Accepted Answer

This is a case of moral hazard, as the borrower took advantage of the funds provided for a specific purpose (home renovation) for personal benefit (gambling trip).

Question 17

You own a car dealership and pay all of your sales people a flat salary. As a result, they don't work very hard to generate sales. This is an example of

Accepted Answer

This is an example of moral hazard, where the salespeople have little incentive to work hard since their salary is not tied to the amount of sales they generate. They may engage in behavior that is not in the best interest of the dealership, such as not putting in effort to close deals or being dishonest with customers.

Question 18

________ is (are) used to distinguish between high and low quality and help correct the adverse selection problem.

Accepted Answer

Market signals, such as branding, customer reviews, and certifications, are used to indicate the quality of a product or service. They help alleviate the adverse selection problem by providing buyers with information that allows them to differentiate between high and low quality options.

Question 19

Relating to the Economics in Practice on page 358: Which of the following is an example of an advertisement in which the fact that something is not mentioned indicates that the product is unlikely to be desirable?

Accepted Answer

The advertisement for the lawn tractor highlights superficial features like paint color and cup holders while omitting crucial information about the engine's condition, suggesting the product may not be desirable.

Question 20

Adverse selection and moral hazard arise because of

Accepted Answer

Adverse selection and moral hazard both stem from the presence of asymmetric information, which means that one party in a transaction has more or better information than the other. In adverse selection, the party with less information is at a disadvantage because they cannot accurately assess the risk of the transaction. In moral hazard, the party with more information may take undue risks or act in a way that is not aligned with the interests of the other party because they know more about the situation. Both situations can lead to market inefficiencies and distortions.

Quiz 17: Uncertainty and Asymmetric Information