Question 1

In corporations, a principal-agent problem can arise when
A)the shareholders are the principal and the managers are the agent.
B)the board of directors is the principal and the managers are the agent.
C)the shareholders are the principal and the board of directors is the agent.
D)All of the above are correct.

Accepted Answer

All of the above choices are correct. The principal-agent problem can arise between different levels and groups of individuals within a corporation, including shareholders and managers, the board of directors and managers, and shareholders and the board of directors. The principal-agent problem occurs when the interests of the principal (such as shareholders or the board of directors) may not align with the interests of the agent (such as managers), leading to conflicts and potentially negative outcomes for the corporation.

Question 2

Peter was recently hired as a salesman for a national consulting firm. His job involves spending a significant portion of his time out of the office visiting prospects and attending conferences. Which of the following is a strategy the consulting firm may employ to discourage Peter from shirking his responsibilities?
A)Tell Peter that the shareholders want to earn a large profit this year.
B)Stop paying Peter bonuses based on how much he's sold.
C)Allow Peter to set his own schedule and work from home frequently.
D)Pay Peter an above-equilibrium wage.

Accepted Answer

Paying Peter an above-equilibrium wage can discourage shirking by making the job more valuable to him, thus incentivizing him to perform well to retain his position.

Question 3

An efficiency wage
A)gives an employee an incentive to shirk his duties.
B)is lower than the equilibrium wage for that position and region.
C)is higher than the equilibrium wage for that position and region.
D)both a and b are correct.

Accepted Answer

An efficiency wage is a wage that is deliberately set higher than the equilibrium wage for a particular job in a specific region. This is done to motivate workers to be more productive and to reduce labor turnover, leading to higher overall efficiency and profitability for the firm. Option A is incorrect because an efficiency wage is intended to provide workers with an incentive to work harder and perform better, not to shirk their duties. Option B is incorrect because an efficiency wage is deliberately set higher than the market equilibrium for that job and region, not lower.

Question 4

You own an ice cream store and are concerned that an employee may be giving generous scoops to friends and relatives and smaller scoops to some other customers. This may be reducing sales. If you want your employee to stop giving larger scoops to friends and relatives, which of the following is not a good approach?
A)Make visits to the store at the same time each day.
B)Pay employees an above equilibrium wage.
C)Give your employees a monthly bonus based on profits.
D)None of the above are good approaches.

Accepted Answer

Making visits to the store at the same time each day is not a good approach because employees can predict when you will be there and may alter their behavior only during those times.

Question 5

Employers can try to overcome the moral-hazard problem involving their employees by
A)paying their employees more often.
B)paying their employees below-equilibrium wages since the employees will likely shirk some of their responsibilities.
C)better monitoring their employees' work efforts.
D)requiring their employees to take a pre-employment work effort test.

Accepted Answer

Better monitoring of employees' work efforts can reduce the moral-hazard problem by providing the employer with information about the employee's work effort. This reduces the employee's incentive to shirk responsibilities because they know they are being monitored. Paying employees more often or requiring pre-employment work effort tests may not necessarily address the moral-hazard problem. Paying employees below-equilibrium wages could exacerbate the problem by increasing the employee's incentive to shirk responsibilities.

Question 6

When a night watchman only performs two walk-throughs per night when he is being paid to perform five walk-throughs per night, it is an example of
A)both moral hazard and adverse selection.
B)neither moral hazard nor adverse selection.
C)moral hazard, but not adverse selection.
D)adverse selection, but not moral hazard.

Accepted Answer

Moral hazard occurs when one party in a transaction has the opportunity to assume additional risks that negatively affect the other party because the latter cannot adequately monitor the former's behavior. In this case, the night watchman's failure to perform the agreed number of walk-throughs, due to the employer's inability to monitor every action, is a classic example of moral hazard. It is not an example of adverse selection, which refers to a situation where one party has more or better information than the other before the transaction occurs, leading to a poor selection of risks.

Question 7

Susan buys automobile insurance from Provident Insurance Company. If Susan avoids having an accident for three years, Provident will reduce the premiums she has to pay for her insurance. Nevertheless, she routinely drives while eating or texting and speeds up to try to make it through yellow lights.
A)This is an adverse selection problem which should be corrected with government intervention.
B)Susan is a principal and Provident is an agent in this principal-agent problem.
C)This is a moral hazard problem.
D)There is no way for Provident to determine whether Susan is a cautious or risky driver.

Accepted Answer

Susan's behavior of driving while distracted and taking risks to make it through yellow lights creates a moral hazard problem for Provident Insurance Company. Moral hazard refers to the increased risk-taking behavior of individuals or firms when they are insured, which can lead to higher costs for the insurer. In other words, Susan's actions increase the likelihood of her getting into an accident, which would result in Provident having to pay out more in insurance claims. Provident may need to adjust premiums or put in provisions to address this behavior.

Question 8

Employers may choose to pay their workers a wage that exceeds the equilibrium wage according to
A)efficiency-wage theories.
B)equilibrium wage theories.
C)screening theories.
D)signaling theories.

Accepted Answer

Employers may choose to pay their workers a wage that exceeds the equilibrium wage according to efficiency-wage theories, which suggest that higher wages can increase worker productivity, lower turnover rates, and attract higher-quality workers. By paying a higher wage than the market would demand, an employer can potentially gain a competitive advantage by creating a more productive workforce.

Question 9

Which of the following is a plausible explanation for a firm paying above-equilibrium wages to its workers?
A)It increases the probability that a worker who shirks will be caught.
B)It discourages workers from shirking out of fear of losing their high-paying job.
C)The Condorcet Paradox suggests that paying high wages will result in greater effort by employees.
D)By paying a high wage, employers solve this adverse selection problem and motivate the employees to work harder.

Accepted Answer

By paying above-equilibrium wages, employers can discourage workers from shirking out of fear of losing their high-paying job.

Question 10

Adverse selection may lead to
A)owners of used cars choosing to keep them rather than sell them at the low price that skeptical buyers are willing to pay.
B)wages being stuck above the level that balances supply and demand, resulting in unemployment.
C)buyers with low risk choosing to remain uninsured because the policies they are offered fail to reflect their true characteristics.
D)All of the above are correct.

Accepted Answer

Adverse selection is a situation in which one party in a transaction has more information than the other party, leading to an imbalance of information. This can lead to all of the above outcomes: owners of used cars may choose to keep them rather than sell at a low price due to skeptical buyers being aware of potential defects, wages may be stuck above the equilibrium level if workers have specialized skills or information that employers are not aware of, and buyers with low risk may remain uninsured if the policies they are offered do not provide adequate coverage or reflect their actual risk level.

Question 11

Suppose you are covered under health insurance or belong to a Health Maintenance Organization (HMO), and you are insured against all or most of the costs of visits to the doctor. As a result you are likely to make greater use of medical services of all kinds. This tendency of people with insurance to change their behavior in a way that leads to more claims against the insurance company is called
A)adverse selection.
B)moral hazard.
C)screening
D)signaling.

Accepted Answer

This phenomenon is called moral hazard, as the individual with insurance may take more risks, knowing that any resulting costs will be covered. Adverse selection refers to the tendency of higher-risk individuals to seek out insurance more often than lower-risk individuals, while screening and signaling refer to the screening process used by insurance companies to evaluate risks and the methods individuals may use to convey their risk level, respectively.

Question 12

A radio story reported a study on the makes and models of cars that were observed going through intersections in the Washington, D.C. area without stopping at the stop signs. According to the story, Volvos were heavily overrepresented; the fraction of cars running stop signs that were Volvos was much greater than the fraction of Volvos in the total population of cars in the D.C. area. This is initially surprising because Volvo has built a reputation as an especially safe car that appeals to sensible, safety-conscious drivers. How is this observation best explained?
A)Volvo drivers are not willing to take risks that they would take in another, less safe car. Driving a Volvo leads to a propensity to run stop signs.
B)Volvo drivers are not willing to take risks that they would take in another, less safe car. Driving a Volvo reduces the propensity to run stop signs.
C)Volvo drivers are willing to take risks that they would not take in another, less safe car. Driving a Volvo reduces the propensity to run stop signs.
D)Volvo drivers are willing to take risks that they would not take in another, less safe car. Driving a Volvo leads to a propensity to run stop signs.

Accepted Answer

This observation could be best explained by the possibility that Volvo drivers, feeling protected by the car's safety features, are more willing to take risks that they would not have taken in another less safe car, leading to a propensity to run stop signs.

Question 13

Peter was recently hired as a salesman for a national consulting firm. His job involves spending a significant portion of his time out of the office visiting prospects and attending conferences. Which of the following is a strategy the consulting firm may employ to discourage Peter from shirking his responsibilities?
A)Tell Peter that the shareholders want to earn a large profit this year.
B)Pay Peter commissions on what he sells after the work has been completed.
C)Allow Peter to set his own schedule and work from home frequently.
D)Pay Peter a lower wage than he would earn in a similar job at another firm.

Accepted Answer

By paying Peter commissions based on completed work, the consulting firm is incentivizing him to work hard and generate sales. This strategy ties Peter's compensation to his performance and makes it less likely that he will shirk his responsibilities. Options A, C, and D do not provide the same level of motivation for Peter to perform well.

Question 14

A college professor hires a student to babysit her children and pays the student an efficiency-wage. Which of the following is correct about the wage the student earns?
A)The wage is higher than the wage the student could earn working a similar job elsewhere.
B)The wage is the same as the wage the student could earn working a similar job elsewhere.
C)The wage is lower than the wage the student could earn working a similar job elsewhere.
D)The wage is likely to result in the student shirking responsibilities.

Accepted Answer

An efficiency-wage is a wage that is higher than the market clearing wage in order to incentivize the worker to be more productive and work harder. In this case, the college professor is likely offering a higher wage than the student could earn babysitting for someone else in order to ensure that the student is motivated to perform well and take good care of her children.

Question 15

Steve borrowed some money from Summit Bank, telling the loan officer that he intended to use the money to remodel his restaurant. After getting the loan, Steve and his girlfriend immediately took the money and went gambling in Vegas.
A)This is an example of adverse selection since banks have difficulty selecting their customers.
B)This example does not involve asymmetric information.
C)From the given information, Steve is the principal and Summit Bank is the agent.
D)None of the above are correct.

Accepted Answer

This is an example of moral hazard, not adverse selection, as Steve misused the funds after receiving the loan.

Question 16

In corporations, which of the following are principals but not agents?
A)shareholders
B)the board of directors
C)managers
D)workers

Accepted Answer

Shareholders are the owners of the corporation and they elect the board of directors, which is the governing body that oversees management and makes major decisions on behalf of the company. Neither shareholders nor the board of directors act as agents of the corporation in day-to-day operations, unlike managers and workers who perform tasks on behalf of the company and can make decisions that bind the corporation.

Question 17

In corporations, which of the following are agents but not principals?
A)shareholders
B)the board of directors
C)managers
D)workers

Accepted Answer

The answer of In corporations, which of the following are...

Question 18

Peter was recently hired as a salesman for a national consulting firm. His job involves spending a significant portion of his time out of the office visiting prospects and attending conferences. His firm is paying him a wage that is higher than the equilibrium wage, but he receives much of his income in quarterly bonuses based on how much he sells.
A)The consulting firm is trying to prevent adverse selection with its compensation strategy.
B)Peter has an incentive to go golfing with his buddies rather than conducting sales meetings.
C)The consulting firm is responding to the moral hazard problem with its compensation strategy.
D)Peter should quit this job and take a job where he gets paid an equilibrium wage more frequently.

Accepted Answer

The consulting firm is responding to the moral hazard problem by offering Peter a higher than equilibrium wage and bonuses based on sales. This is meant to incentivize him to put in the effort to make sales and not shirk his responsibilities while out of the office. The higher wage also serves as a deterrent to him leaving the job for a lower paying one where he may have less responsibility. Adverse selection and the potential for Peter to go golfing with his buddies are not addressed by this compensation strategy. There is no indication that Peter should quit his job for a lower paying one, as he may not be able to find a job that satisfies his preferences and meets his financial needs.

Question 19

You own an ice cream store and are concerned that an employee may be giving generous scoops to friends and relatives and smaller scoops to some other customers. This may be reducing sales. In this example, you are the
A)principal and the your employee is the agent.
B)agent and the your employee is the principal.
C)signaler and the your employee is the screener.
D)screener and the owner of the coffee ship is the signaler.

Accepted Answer

In this scenario, the owner of the ice cream store is the principal and the employee is the agent. The owner has hired the employee to sell ice cream and has entrusted them to represent the store in a positive manner. However, the employee's actions are potentially hurting the business by giving unequal scoops to customers. The owner has the right to monitor and correct the behavior of the employee to ensure that the business is running smoothly and fairly.

Question 20

Kim owns a small business in Denver. She travels frequently, meeting with important customers, and attending conferences. Kim hired Matt to work in the Denver office as the day-to-day general manager of the business.
A)This is a moral hazard problem since Matt may not work as hard as Kim would like when he is not monitored.
B)Kim choosing to hire Matt is an example of adverse selection since it is possible that Matt will not work as hard as Kim expects.
C)Kim will most likely pay Matt a lower salary than normal since Kim will not be there to monitor Matt's work effort, and since Matt will not likely work hard knowing Kim cannot monitor his effort.
D)Kim is the agent and Matt is the principal.

Accepted Answer

Moral hazard occurs when one party takes risks because they do not have to bear the full consequences, often due to lack of monitoring. Here, Matt may not work as hard as Kim desires when unsupervised.

Quiz 22: Frontiers in Microeconomics

In corporations, a principal-agent problem can arise when

An efficiency wage

Employers can try to overcome the moral-hazard problem involving their employees by

When a night watchman only performs two walk-throughs per night when he is being paid to perform five walk-throughs per night, it is an example of

Employers may choose to pay their workers a wage that exceeds the equilibrium wage according to

Which of the following is a plausible explanation for a firm paying above-equilibrium wages to its workers?

Adverse selection may lead to

A college professor hires a student to babysit her children and pays the student an efficiency-wage. Which of the following is correct about the wage the student earns?

Steve borrowed some money from Summit Bank, telling the loan officer that he intended to use the money to remodel his restaurant. After getting the loan, Steve and his girlfriend immediately took the money and went gambling in Vegas.

In corporations, which of the following are principals but not agents?

In corporations, which of the following are agents but not principals?

You own an ice cream store and are concerned that an employee may be giving generous scoops to friends and relatives and smaller scoops to some other customers. This may be reducing sales. In this example, you are the

Kim owns a small business in Denver. She travels frequently, meeting with important customers, and attending conferences. Kim hired Matt to work in the Denver office as the day-to-day general manager of the business.