Question 1

If the seller of a used car offers a limited warranty, the warranty is an example of
A)a signal.
B)a screen.
C)an efficiency wage.
D)an agent.

Accepted Answer

A limited warranty serves as a signal to potential buyers about the quality of the used car, indicating that the seller is confident enough in the vehicle's condition to offer a warranty.

Question 2

In corporations, which of the following are the principals in the principal-agent relationship?
A)Shareholders
B)The board of directors
C)Managers
D)Workers

Accepted Answer

Shareholders are the principals in the principal-agent relationship because they own the company and hire agents (managers) to run it on their behalf.

Question 3

Which of the following is an example of an adverse selection problem?
A)A customer purchases four apples, two of which are bruised.
B)A card shop puts its Halloween merchandise on sale on November 1st.
C)A young job applicant fails to reveal that she was fired from her last job because she was incompetent.
D)A man rents a car and then drives it less carefully and fills it with cheaper gas than he would if he owned it.

Accepted Answer

Adverse selection occurs when one party in a transaction has more information than the other, typically leading to a poor outcome for the less informed party. In choice C, the job applicant withholding information about her past job performance is an example of adverse selection, as the employer is making a decision without all the relevant information.

Question 4

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 5

People with hidden health problems are more likely to buy health insurance than are other people. This is an example of
A)moral hazard and makes the cost of health insurance higher than otherwise.
B)moral hazard and makes the cost of health insurance lower than otherwise.
C)adverse selection and makes the cost of health insurance higher than otherwise.
D)adverse selection and makes the cost of health insurance lower than otherwise.

Accepted Answer

This is an example of adverse selection, where individuals with a higher risk of needing healthcare (due to hidden health problems) are more likely to purchase health insurance. This can lead to a higher average cost for the insurer, which in turn can lead to higher premiums for all insured individuals.

Question 6

Adverse selection
A)occurs when the overall quality of choices facing a consumer is very low.
B)is a greater problem for employees than employers.
C)occurs more frequently in the market for new cars than used cars.
D)is not easily remedied by free markets.

Accepted Answer

Adverse selection is a situation where sellers have information that buyers do not have, or vice versa, about some aspect of product quality. In the context of markets, it refers to a scenario where the presence of information asymmetry leads to high-quality goods being squeezed out of the market by low-quality goods, because buyers cannot accurately assess the quality of a product. This problem is particularly pronounced in markets where it's hard for buyers to distinguish between high-quality and low-quality products before purchase, such as the insurance market. Free markets often struggle to correct for adverse selection on their own because the root of the problem lies in asymmetric information, which market mechanisms alone may not be able to resolve without external interventions like regulations or signaling mechanisms (e.g., warranties, certifications).

Question 7

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 directly addresses the moral-hazard problem by ensuring that employees are fulfilling their responsibilities and not shirking their duties.

Question 8

Scenario 22-1
​
Shana owns a boutique that sells high-end women's clothing and accessories. Katie works part-time at the boutique and frequently is the only employee in this small store. Shana pays Katie a wage that is higher than the market wage for this type of job. When the store is not full of customers, Katie diligently works on displays and cleans to keep the store looking its best. Belinda is a customer in the store who asks Katie's opinion on the quality of some blouse she is considering purchasing. Even though she's had several other customers return this type of blouses due to flaws, Katie tells Belinda the quality is great. Magda is another customer who is returning a necklace without revealing that she lost a gem from it while wearing it.
-Refer to Scenario 22-1. Which of the ladies is causing a moral hazard problem?
A)Shana
B)Katie
C)Belinda
D)Magda

Accepted Answer

Katie is causing a moral hazard problem by misrepresenting the quality of the blouses to Belinda, despite knowing about the flaws.

Question 9

Which of the following events best exemplifies the concept of signaling?
A)A college student's parents, having learned that their child is short of money, send her a check for $1,000.
B)A new company making high quality bicycles at a reasonable price sends free bikes to reviewers working for bicycle magazines.
C)A grocery store maintains a policy of examining the driver's license of everyone who writes a personal check to purchase his groceries.
D)A university maintains a policy of considering for admission only those students who graduated among the top 10 percent of their high school class.

Accepted Answer

B) A new company making high quality bicycles at a reasonable price sends free bikes to reviewers working for bicycle magazines exemplifies the concept of signaling. This action signals the quality of their product to potential customers through the endorsements of respected reviewers.

Question 10

Scenario 22-1
​
Shana owns a boutique that sells high-end women's clothing and accessories. Katie works part-time at the boutique and frequently is the only employee in this small store. Shana pays Katie a wage that is higher than the market wage for this type of job. When the store is not full of customers, Katie diligently works on displays and cleans to keep the store looking its best. Belinda is a customer in the store who asks Katie's opinion on the quality of some blouse she is considering purchasing. Even though she's had several other customers return this type of blouses due to flaws, Katie tells Belinda the quality is great. Magda is another customer who is returning a necklace without revealing that she lost a gem from it while wearing it.
-Refer to Scenario 22-1. Which of the ladies is a principal?
A)Shana
B)Katie
C)Belinda
D)Magda

Accepted Answer

Shana is the principal because she owns the boutique and employs Katie, making her responsible for the business and its operations.

Question 11

Scenario 22-1
​
Shana owns a boutique that sells high-end women's clothing and accessories. Katie works part-time at the boutique and frequently is the only employee in this small store. Shana pays Katie a wage that is higher than the market wage for this type of job. When the store is not full of customers, Katie diligently works on displays and cleans to keep the store looking its best. Belinda is a customer in the store who asks Katie's opinion on the quality of some blouse she is considering purchasing. Even though she's had several other customers return this type of blouses due to flaws, Katie tells Belinda the quality is great. Magda is another customer who is returning a necklace without revealing that she lost a gem from it while wearing it.
-Refer to Scenario 22-1. Which of the ladies is an agent?
A)Shana
B)Katie
C)Belinda
D)Magda

Accepted Answer

Katie acts on behalf of Shana, the boutique owner, making her an agent in this scenario.

Question 12

Employers who choose to pay their workers a wage that exceeds the equilibrium wage are acting in accordance with
A)efficiency-wage theories.
B)equilibrium wage theories.
C)screening theories.
D)signaling theories.

Accepted Answer

Efficiency-wage theories suggest that paying workers more than the equilibrium wage can lead to increased productivity, loyalty, and reduced turnover, which can be beneficial for the employer in the long run.

Question 13

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

Efficiency wages are set above the market rate to increase worker productivity and loyalty, implying that the student is paid more than what they would earn in a similar job elsewhere.

Question 14

The classic example of adverse selection is the
A)market for used cars.
B)market for new cars.
C)relationship between shareholders and managers.
D)relationship between a coach and an athlete.

Accepted Answer

The classic example of adverse selection is the market for used cars, famously described in George Akerlof's "The Market for Lemons" paper. In this market, sellers have more information about the quality of the car than buyers, leading to a market where only lower-quality cars (lemons) are sold at a price that does not reflect their true value.

Question 15

A firm with a very good product
A)has a higher cost of signaling with advertising than does a firm with an inferior product.
B)has more to gain by signaling with advertising than does a firm with an inferior product.
C)does not need to signal with advertising because the product's quality speaks for itself.
D)will signal with advertising effectively if signaling is free.

Accepted Answer

A firm with a very good product has more to gain by signaling with advertising than does a firm with an inferior product because advertising can help differentiate its superior product from competitors, potentially increasing its market share and profitability.

Question 16

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 your employee is the agent.
B)agent and your employee is the principal.
C)signaler and your employee is the screener.
D)screener and your employee is the signaler.

Accepted Answer

In this scenario, you are the principal because you own the ice cream store and have hired the employee to perform tasks on your behalf. The employee acts as the agent, carrying out duties under your direction. This relationship is a classic example of the principal-agent problem, where the agent (employee) may have personal interests that conflict with those of the principal (employer or store owner).

Question 17

A safe driver would likely choose an auto insurance policy with a
A)low premium and a high deductible.
B)high premium and a high deductible.
C)high premium and a low deductible.
D)high premium and no deductible.

Accepted Answer

A low premium and high deductible policy means the driver would pay less on a regular basis (low premium) but would be responsible for a higher out-of-pocket cost before insurance kicks in (high deductible). This is often chosen by safe drivers who anticipate fewer claims and are willing to risk a higher deductible for the benefit of lower ongoing costs.

Question 18

An unhealthy person would likely choose a medical insurance policy with a
A)low premium and a high deductible.
B)high premium and a high deductible.
C)high premium and no deductible.
D)The unhealthy person would choose not to be insured.

Accepted Answer

Unhealthy individuals are likely to choose a policy with a high premium and no deductible because they expect to need significant medical care. This option minimizes out-of-pocket expenses for frequent or high-cost treatments.

Question 19

When the buyer knows less than the seller about the characteristics of the good being sold, there is
A)a principal-agent problem.
B)a moral hazard problem.
C)an adverse selection problem.
D)a signaling problem.

Accepted Answer

An adverse selection problem occurs when one party in a transaction has more information than the other, typically seen in markets for goods like used cars or insurance, where the seller or provider knows more about the product or service than the buyer or applicant.

Question 20

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 the adverse selection problem and motivate the employees to work harder.

Accepted Answer

Paying above-equilibrium wages can discourage workers from shirking because they value their higher-than-average salary and fear losing their job, which aligns with the efficiency wage theory.

Quiz 22: Frontiers in Microeconomics

If the seller of a used car offers a limited warranty, the warranty is an example of

In corporations, which of the following are the principals in the principal-agent relationship?

Which of the following is an example of an adverse selection problem?

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

People with hidden health problems are more likely to buy health insurance than are other people. This is an example of

Adverse selection

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

Which of the following events best exemplifies the concept of signaling?

Employers who choose to pay their workers a wage that exceeds the equilibrium wage are acting in accordance with

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?

The classic example of adverse selection is the

A firm with a very good product

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 safe driver would likely choose an auto insurance policy with a

An unhealthy person would likely choose a medical insurance policy with a

When the buyer knows less than the seller about the characteristics of the good being sold, there is

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