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 have about their customers.

Accepted Answer

The licensing and regulation of financial advisers is aimed at ensuring that advisers have the necessary qualifications and adhere to ethical standards, addressing the issue of information asymmetry between advisers and clients, not between firms and customers.

Question 2

An effective antipollution policy from the economic perspective requires that all pollution be eliminated and banned.

Accepted Answer

Eliminating and banning all pollution is not economically feasible or practical. Instead, policies should aim to reduce and mitigate the negative impacts of pollution while balancing the costs and benefits to industry and society. This may involve setting emissions standards, implementing taxes or markets for pollution permits, and investing in clean technology and infrastructure.

Question 3

There are no external costs with being on the roadways during peak driving hours; there are only private costs that include your gasoline and opportunity cost of time spent in traffic.

Accepted Answer

External costs, such as increased pollution and wear and tear on the roads, affect the community and environment, not just the individual driver. These are in addition to private costs like gasoline and time.

Question 4

In a well-functioning cap-and-trade system for pollution rights, society benefits because pollution will be brought down to insignificant levels.

Accepted Answer

A well-functioning cap-and-trade system aims to reduce pollution to regulated levels, not necessarily to insignificant levels. The goal is to limit emissions to a level deemed acceptable by regulatory bodies, not eliminate them entirely.

Question 5

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

Accepted Answer

When banks know that they will be bailed out by the government if they become unstable, they may take on more risks and engage in reckless behavior because they are not fully responsible for the consequences of their actions. This creates a moral hazard problem, as the government intervention may incentivize banks to take on excessive risks, knowing that they will be bailed out if their behavior leads to financial instability.

Question 6

The Coase theorem suggests that the government does not have to be involved at all in resolving a market failure due to externalities.

Accepted Answer

The Coase theorem states that if property rights are well-defined and transaction costs are low, parties will bargain and negotiate to reach an efficient outcome, even in the presence of externalities. Therefore, the government intervention may not be necessary to resolve market failures associated with externalities.

Question 7

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 occurs when one party has more information than the other, leading to a selection bias in favor of the party with more information. In the case of insurance, people who are more likely to claim payouts (e.g. those with pre-existing conditions or risky behavior) are more likely to seek out insurance policies with greater coverage, resulting in adverse selection for the insurance company.

Question 8

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

Accepted Answer

Bailing out homeowners who are defaulting on their mortgages can create a moral hazard problem because it may encourage people to take out larger mortgages or engage in risky behavior with the expectation that the government will bail them out if they get into financial trouble.

Question 9

If the lumber companies are required to internalize the negative externalities of deforestation, then we should expect the equilibrium price of wooden furniture to decrease.

Accepted Answer

Internalizing the negative externalities of deforestation typically means that lumber companies would incur additional costs (such as taxes or fees for environmental damage) which would increase the cost of producing wooden furniture, leading to a higher equilibrium price.

Question 10

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

The moral hazard problem refers to a situation where individuals may engage in riskier behavior or not exert effort to avoid a negative outcome because they are insulated from the consequences, in this case, by receiving unemployment benefits.

Question 11

People with high opportunity costs for time won't mind sitting in traffic.

Accepted Answer

People with high opportunity costs for time value their time highly and would likely mind sitting in traffic as it represents a loss of valuable time that could be spent on more productive activities.

Question 12

eBay 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

eBay and Amazon both provide sellers' ratings to help potential buyers make informed decisions and reduce the adverse selection problem.

Question 13

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 is defined as a situation where one party in a transaction has more information than the other. It can lead to the less-informed party making decisions that are not in their best interest.

Question 14

Jennifer buys a piece of costume jewelry for $30, for which she was willing to pay $35. The minimum acceptable price to the seller, Nathan, was $15. Jennifer experiences a

Accepted Answer

Jennifer's consumer surplus is the difference between what she was willing to pay ($35) and what she actually paid ($30), which is $5. Nathan's producer surplus is the difference between what he received ($30) and his minimum acceptable price ($15), which is $15.

Question 15

In dealing with market failures, the government always bases its decisions on economic analysis of marginal cost and marginal benefit.

Accepted Answer

While economic analysis of marginal cost and marginal benefit is an important tool, government decisions on dealing with market failures may also be influenced by political, social, and ethical considerations, not solely by economic analysis.

Question 16

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

Question 17

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 18

Production subsidies are a way of internalizing external costs among polluting firms.

Accepted Answer

Production subsidies are financial support from the government to firms, often aimed at reducing production costs or encouraging output of certain goods, not specifically for internalizing external costs, which is more directly addressed by policies like taxes or regulations on pollution.

Question 19

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

The answer of Adverse selection is when someone with home...

Question 20

The government should choose pollution abatement for all sources of pollution where the marginal benefit exceeds the marginal cost of that action.

Accepted Answer

This statement aligns with the principle of economic efficiency, where actions should be taken up to the point where the marginal benefit equals the marginal cost. If the marginal benefit of pollution abatement exceeds the marginal cost, it indicates that the action would yield net positive benefits to society, making it a desirable choice.

Quiz 4: Market Failures Caused by Externalities Asymmetric Information