Question 1

The domination of the used car market by lemons is an example of the ________ problem.
A) adverse selection
B) moral hazard
C) perfect information
D) marginal analysis

Accepted Answer

The domination of the used car market by lemons is an example of adverse selection. Adverse selection refers to the situation where one party to a transaction has more information than the other and uses this information advantage to the detriment of the less-informed party. In the used car market, sellers of lemons (low-quality cars) have more information about the true condition of their cars than the buyers do, and they use this advantage to sell their lemons at higher prices than they would get if buyers had perfect information. This drives out the high-quality cars from the market, leading to a market dominated by lemons.

Question 2

Table 14.1
-Refer to Table 14.1,which shows the market for used motorcycles in a small Midwestern town.As buyers adjust their expectations of lemons in this market,
A) the price they will be willing to pay will rise.
B) the quantity of plums supplied will rise.
C) the proportion of lemons in the market will rise.
D) all of the above

Accepted Answer

As buyers adjust their expectations of lemons in the market for used motorcycles, the proportion of lemons in the market will rise. This means that there will be a higher number of low-quality motorcycles being sold, which will lead to a decrease in the average quality of motorcycles in the market. This, in turn, will lower the price that buyers are willing to pay for motorcycles and reduce the quantity of plums supplied. Therefore, only choice C is correct.

Question 3

An example of adverse selection is
A) when high-quality loan applicants drive low-quality loan applicants out of the market for bank loans.
B) when a person discovers that he has a serious illness and then purchases health insurance.
C) when consumers are not willing to pay top dollar for a used car because of imperfect information.
D) All of the above are examples of adverse selection.

Accepted Answer

C

Question 4

Table 14.2
-Refer to table 14.2.The buyers assumed chance of getting a lemon will ________ and hence the willingness to pay for the used boat will ________.
A) fall; rise
B) rise; fall
C) fall; fall
D) rise; rise

Accepted Answer

If the buyers assume the chance of getting a lemon falls, they perceive less risk, which increases their willingness to pay for the used boat.

Question 5

You want to purchase a new car.You have gone to 3 dealerships that sell the type of car you want.The price of the car is different at each of the dealerships.You have estimated that if you go to another dealership,the marginal amount you may save will be $250,but the marginal cost of going to the dealership would be $350.Which of the following statements is accurate?
A) You should go to the next dealership, as you would be able to save an additional $250.
B) In order to determine whether or not you should go to the next dealership, you would need to know the total costs and total benefits of this action.
C) You should not go to the next dealership because the marginal cost of this action exceeds the marginal benefit.
D) You should continue going to dealerships as long as the marginal benefit of additional search is positive.

Accepted Answer

The marginal cost of going to the next dealership exceeds the marginal benefit, so it would not be the best choice to visit the next dealership. Continuing to search for dealerships as long as the marginal benefit is positive (Option D) may not be the best choice if the marginal cost exceeds the marginal benefit, as it does in this case. To determine whether or not to go to the next dealership, it would not necessarily require knowing the total costs and benefits (Option B), but rather just comparing the marginal cost and marginal benefit of the next visit. Therefore, Option C is the best choice.

Question 6

Dan is trying to sell a high-quality used desktop computer,but all potential buyers are not willing to pay the price that Dan wants.This is likely due to a(n)________ problem.
A) moral hazard
B) disutility
C) adverse selection
D) price discrimination

Accepted Answer

Adverse selection occurs when there is a difference in information between the buyer and the seller. In this case, potential buyers may not see the value in the computer that Dan is selling, and may be offering lower prices than he expects. This could be because they do not fully understand the quality of the computer or its features.

Question 7

A situation in which the uninformed side of the market must choose from an undesirable selection of goods is an example of
A) indifferent information.
B) perfect information.
C) asymmetric information.
D) a thick market.

Accepted Answer

This situation is an example of asymmetric information, where one party in a transaction has more or better information than the other. This often leads to adverse selection, where the uninformed side is left with a pool of undesirable choices.

Question 8

Suppose that buyers in the used electric washer market are willing to pay $100 for a high-quality electric washer and $50 for a low-quality electric washer.If buyers believe that 70% of all used electric washer are low-quality,what is the maximum price they would be willing to pay for a used electric washer?
A) $35
B) $50
C) $65
D) $70

Accepted Answer

Given that buyers are willing to pay $100 for high-quality washer and $50 for the low-quality one. If buyers believe that 70% of all used electric washer are low-quality, then the expected value of the washer is:
($100 x 30%) + ($50 x 70%) = $30 + $35 = $65
Therefore, the maximum price buyers are willing to pay for a used electric washer is $65.

Question 9

Table 14.1
-Refer to Table 14.1,which shows the market for used motorcycles in a small Midwestern town.Which of the following is true?
A) The market is in equilibrium.
B) We can expect the price of used motorcycles to fall.
C) We can expect the price of used motorcycles to rise.
D) Buyers' willingness to pay for a used motorcycle will remain unchanged.

Accepted Answer

If the market is not in equilibrium, and there is an excess supply of used motorcycles, we can expect the price to fall to reach equilibrium.

Question 10

In the market for automobile insurance,asymmetric information occurs when
A) insured drivers drive more safely than uninsured drivers.
B) insured drivers drive more recklessly than uninsured drivers.
C) drivers with greater risk purchase more automobile insurance.
D) automobile insurance is universal.

Accepted Answer

Asymmetric information in the context of automobile insurance occurs when one party (in this case, the drivers) has more or better information than the other party (the insurance company). Choice C is correct because it describes a situation where drivers who are aware of their higher risk (due to their driving habits, history, or other factors) opt to purchase more insurance, while the insurance company may not have access to this detailed personal information, leading to a mismatch in information between the two parties.

Question 11

The lemons problem may cause markets with asymmetric information
A) to reduce the number of low-quality goods.
B) to reduce the number of high-quality goods.
C) to increase the number of high-quality goods.
D) to increase the average quality of goods.

Accepted Answer

The lemons problem, as described by George Akerlof, suggests that in markets with asymmetric information, where sellers have more information about the quality of goods than buyers, there tends to be a reduction in the number of high-quality goods. This is because buyers, unable to distinguish between high and low-quality goods, are only willing to pay a price that reflects the average quality. This, in turn, drives out the high-quality goods, leaving a market dominated by "lemons," or low-quality goods.

Question 12

Table 14.2
-Refer to Table 14.2,which shows the market for used fishing boats.Which of the following is NOT true about this market?
A) The price buyers will be willing to pay will rise.
B) The quantity of plums supplied will rise.
C) The proportion of lemons in the market will rise.
D) All of the above are false.

Accepted Answer

The table shows that the proportion of lemons (low-quality boats) in the market will actually decrease over time, not rise. Therefore, option C is false, while options A and B are true.

Question 13

Table 14.2
-Refer to Table 14.2,which shows the market for used fishing boats.Which of the following is true about this market?
A) The market is in equilibrium.
B) We can expect the price of used boats to fall.
C) We can expect the price of used boats to rise.
D) Buyers' willingness to pay for a used boat will fall.

Accepted Answer

Given that the market for used fishing boats is likely experiencing a situation where demand exceeds supply at the current price, this imbalance would naturally lead to an increase in prices as sellers realize they can charge more due to the higher demand for their limited supply of boats.

Question 14

Because of asymmetric information,a seller of a lemon used car earns
A) more profit than a seller of a plum used car.
B) less profit than a seller of a plum used car.
C) the same profit as a seller of a plum used car.
D) less revenue than a seller of a plum used car.

Accepted Answer

Because of asymmetric information, the seller of a lemon used car has more information about the car's quality than the buyer. This allows the seller to earn more profit by selling the car for a higher price than it is worth.

Question 15

Suppose that buyers in the used refrigerator market are willing to pay $500 for a high-quality refrigerators and $200 for a low-quality refrigerators.If buyers believe that 50% of all used refrigerators are low-quality,what is the maximum price they would be willing to pay for a used refrigerator?
A) $200
B) $340
C) $350
D) $500

Accepted Answer

Buyers will calculate the expected value of a used refrigerator based on the probability of getting a high-quality or low-quality one. The expected value is 0.5 * $500 + 0.5 * $200 = $350.

Question 16

On an automobile insurance policy,a deductible is the dollar amount that the driver will pay toward damages before the insurance company will pay anything.Asymmetric information suggests that
A) high-risk drivers will buy a policy without any deductible.
B) high-risk drivers will buy a policy with a very high deductible.
C) insured drivers drive more safely than uninsured drivers.
D) insured drivers drive more recklessly than uninsured drivers.

Accepted Answer

High-risk drivers are more likely to buy a policy without any deductible because they anticipate needing to make claims and want to minimize their out-of-pocket expenses. This is a result of asymmetric information, where the insurer cannot fully assess the risk level of the driver.

Question 17

In the market for used boats there are high-quality boats and poor-quality boats.Potential buyers cannot determine prior to purchase whether the boat is high quality or low quality.Which of the following statements best describes what is likely to happen in this market?
A) The price of a used boat will be very close to the value of a high-quality motorcycle, which will encourage people to sell high-quality boats.
B) The price of a used boat will be between the value of a high-quality and low-quality boat. This will encourage people to withdraw high-quality boats from the market.
C) The price of a used boat will be very close to the value of a low-quality boat, since the buyer will not be willing to pay any more than this price given the uncertainly of what they will get.
D) No used boats will be bought or sold given the uncertainty faced by the buyer.

Accepted Answer

This scenario is an example of the "market for lemons" problem described by George Akerlof. In a market where quality cannot be easily assessed by buyers, the price tends to reflect an average of high and low-quality goods. Sellers of high-quality boats know their boats are worth more than this average price, so they are less likely to sell, leading to a market where only lower-quality boats are sold.

Question 18

The result of adverse selection is that
A) higher-quality producers drive lower-quality producers out of the market.
B) lower-quality producers drive higher-quality producers out of the market.
C) consumers will be able to purchase only high-quality products.
D) higher-quality producers receive a higher price than they would if adverse selection was not present.

Accepted Answer

Adverse selection occurs when lower-quality producers are able to offer lower prices, which attracts consumers away from the higher-quality producers. This results in higher-quality producers being driven out of the market, leaving only lower-quality producers. Therefore, answer B is correct. Option A is incorrect because it is the opposite of the outcome of adverse selection. Option C is incorrect because adverse selection leads to a decrease in the availability of high-quality products. Option D is also incorrect because adverse selection results in lower-quality producers being able to offer lower prices, so they would not receive higher prices.

Question 19

If one side of the market,either the buyer or seller of a good or service,has better information than the other side,there is
A) moral hazard.
B) asymmetric information.
C) an external cost.
D) a free-rider problem.

Accepted Answer

Asymmetric information occurs when one side of the market has better information than the other. This can lead to a market failure, as the party with less information may make decisions that are not in their best interest. Moral hazard refers to the tendency for people to take risks when they are insured against losses. External cost refers to the cost that affects people who are not directly involved in a transaction. Free-rider problem occurs when people benefit from a good or service without paying for it.

Question 20

Adverse selection describes the situation that occurs when
A) people have perfect information.
B) high-quality products are driven from the market by low-quality products due to imperfect information.
C) actions that were expected to happen do not occur.
D) low-quality products are driven from the market by high-quality products because of imperfect information.

Accepted Answer

Adverse selection occurs when there is asymmetric information between buyers and sellers, leading to high-quality products being driven out of the market by low-quality products because buyers cannot accurately assess the quality of a product before purchasing.

Quiz 14: Imperfect Information: Adverse Selection and Moral Hazard

The domination of the used car market by lemons is an example of the ________ problem.

Table 14.1 -Refer to Table 14.1,which shows the market for used motorcycles in a small Midwestern town.As buyers adjust their expectations of lemons in this market,

An example of adverse selection is

Table 14.2 -Refer to table 14.2.The buyers assumed chance of getting a lemon will and hence the willingness to pay for the used boat will .

Dan is trying to sell a high-quality used desktop computer,but all potential buyers are not willing to pay the price that Dan wants.This is likely due to a(n) ________ problem.

A situation in which the uninformed side of the market must choose from an undesirable selection of goods is an example of

Table 14.1 -Refer to Table 14.1,which shows the market for used motorcycles in a small Midwestern town.Which of the following is true?

In the market for automobile insurance,asymmetric information occurs when

The lemons problem may cause markets with asymmetric information

Table 14.2 -Refer to Table 14.2,which shows the market for used fishing boats.Which of the following is NOT true about this market?

Table 14.2 -Refer to Table 14.2,which shows the market for used fishing boats.Which of the following is true about this market?

Because of asymmetric information,a seller of a lemon used car earns

Suppose that buyers in the used refrigerator market are willing to pay $500 for a high-quality refrigerators and $200 for a low-quality refrigerators.If buyers believe that 50% of all used refrigerators are low-quality,what is the maximum price they would be willing to pay for a used refrigerator?

On an automobile insurance policy,a deductible is the dollar amount that the driver will pay toward damages before the insurance company will pay anything.Asymmetric information suggests that

In the market for used boats there are high-quality boats and poor-quality boats.Potential buyers cannot determine prior to purchase whether the boat is high quality or low quality.Which of the following statements best describes what is likely to happen in this market?

The result of adverse selection is that

If one side of the market,either the buyer or seller of a good or service,has better information than the other side,there is

Adverse selection describes the situation that occurs when