Question 1

Suppose an agent must pay the full marginal cost for an item but splits the marginal revenue with the principal.As a result,
A) joint profit is maximized.
B) joint profit is not maximized.
C) the agent will not enter into such a contract.
D) the agent wishes to sell as many items as he can.

Accepted Answer

The agent would have less incentive to sell the item because they only receive a portion of the marginal revenue, while still having to pay the full marginal cost. This leads to less overall sales and less joint profit. Therefore, joint profit is not maximized in this scenario.

Question 2

Suppose the principal offers to share a percentage of the profit with the agent.Such a contract
A) will yield the same income for the agent as a hire contract would.
B) is incentive compatible.
C) creates a production inefficiency.
D) would not be acceptable to any agent.

Accepted Answer

A profit-sharing contract creates incentives for the agent to work hard to increase the profits, as they will receive a percentage of the profits. This makes it incentive compatible. It may or may not yield the same income as a hire contract, depending on how successful the business is. It does not necessarily create a production inefficiency, as long as the contract is designed in a way that aligns the interests of the principal and agent. It may or may not be acceptable to some agents, depending on their risk preferences and beliefs about their ability to affect profits.

Question 3

In professional golf,a tournament winner might win,say,$1 million,whereas second place wins only $600,000.Why might golf have a 40% reduction in prize money from first and second place?
A) To ensure that there is enough money to pay those who finish near last.
B) To motivate golfers to take risks they might not otherwise take.
C) To motivate golfers to not take risks they might otherwise take.
D) The Professional Golfers Association is a cartel.

Accepted Answer

The reduction in prize money from first and second place is meant to motivate golfers to take risks they might not otherwise take in order to try and win the tournament. This adds excitement and strategy to the game, as golfers must weigh the potential reward against the potential risks.

Question 4

Season ticket holders often purchase their tickets before a season begins.There is often a discount associated with season tickets.Why?
A) Buying season tickets entails risk, which consumers are willing to bear if they are compensated for doing so.
B) Buying season tickets is a way of guaranteeing a supply of tickets for the secondary market.
C) Selling season tickets entails greater transactions costs which team owners hope to avoid.
D) Sports teams are local monopolies.

Accepted Answer

Season tickets entail a risk for consumers because they are purchasing tickets for events that may not happen or may not be as desirable as anticipated. Therefore, sports teams offer a discount on season tickets as a way to compensate consumers for taking on this risk.

Question 5

Many professional sports athletes have incentive clauses in their contracts.These indicate that
A) the team owner has asymmetric information.
B) the athlete might engage in moral hazard, which the team owner wishes to avoid.
C) the athlete might engage in adverse selection, which the team owner wishes to avoid.
D) the athlete has stronger negotiators.

Accepted Answer

Incentive clauses in contracts are designed to prevent moral hazard. This is where an individual has an incentive to take risks because they do not bear the full consequences of their actions. In the case of professional sports, the athlete may have an incentive to underperform or take unnecessary risks because they know that they will still receive their regular salary. The incentive clauses provide additional performance-based compensation, which aligns the athlete's interests with those of the team owner.

Question 6

Production efficiency implies that
A) joint profits are maximized.
B) joint profits are minimized.
C) joint profits are zero.
D) joint profits can be increased.

Accepted Answer

Production efficiency occurs when an economy or a production process is operating in such a way that it cannot produce more of one good without producing less of another. This implies that resources are allocated in the most efficient manner, leading to the maximization of joint profits.

Question 7

What is one potential problem with nationalized health care?
A) It might not be efficient in risk bearing.
B) It is guaranteed to solve the principal-agent problem.
C) It would be efficient in risk bearing.
D) It might cost too much.

Accepted Answer

Nationalized health care may not be efficient in risk bearing, as the cost of providing comprehensive health care to all citizens may be too high to bear for a single government entity. This can lead to long waiting times, rationing of services, and reduced quality of care for patients.

Question 8

Efficiency in risk bearing implies that
A) risk is completely eliminated.
B) the least risk-averse party bears most of the risk.
C) the most risk-averse party bears most of the risk.
D) all of the risk is borne by just one of the parties regardless of the degree of risk aversion.

Accepted Answer

Efficiency in risk bearing suggests that the party that is the least risk-averse should bear most of the risk. This allows for the total cost of risk to be minimized since the party that is less averse to risk will require less compensation to bear it. This allocation of risk is beneficial to both parties as it reduces overall costs and improves efficiency.

Question 9

The type of contract selected depends on the information available to the parties.

Accepted Answer

The efficiency in production and risk bearing from a specific contract will depend on the information available to the principal and agent.

Question 10

In a store that sells souvenirs,suppose an agent receives a $1 commission for each unit sold,and the principal receives the residual profit.As a result,
A) joint profit is maximized.
B) the agent will sell until the principal's marginal cost equals $1.
C) no agent would enter into such a contract.
D) the agent wishes to sell as many units as he can.

Accepted Answer

The agent is motivated to sell as many units as possible because their commission is directly tied to the number of units sold, regardless of the cost or profit implications for the principal. This setup incentivizes the agent to maximize sales volume to increase their commission earnings.

Question 11

We can say that a contract is able to prevent moral hazard when
A) it eliminates production inefficiencies due to moral hazard without shifting risk to risk-averse people.
B) it eliminates production inefficiencies due to moral hazard without shifting risk to risk-loving people.
C) it shifts risk to risk-loving people.
D) it eliminates production inefficiencies due to moral hazard and shifts risk to risk-averse people.

Accepted Answer

A contract that eliminates production inefficiencies due to moral hazard without shifting risk to risk-averse people is the most ideal scenario for preventing moral hazard. This means that the contract addresses the root cause of inefficiencies without unfairly burdening those who are risk-averse. Shifting risk to risk-loving people may not necessarily prevent moral hazard, as these individuals may be willing to take risks that actually increase inefficiencies.

Question 12

The outcome of the state of nature effects the payoff to the agent under a
A) fixed-fee contract.
B) hire contract.
C) contingent contract.
D) All of the above.

Accepted Answer

The outcome of the state of nature, which is uncertain, affects the payoff of the agent under a contingent contract, where the payment or reward depends on the outcome of a specific event or situation. This type of contract is designed to incentivize the agent to act in the principal's interest and take actions that maximize the likelihood of the desired outcome. In fixed-fee and hire contracts, the payment to the agent is predetermined and does not depend on the outcome of the state of nature.

Question 13

Production inefficiency is most likely to occur when the principal has more information about work performance than the agent does.

Accepted Answer

It is when the agent has more information that production inefficiency is more likely to occur.The agent is able to shirk without being detected by the principal.

Question 14

Describe the characteristics of an efficient contract between a principal and an agent.

Accepted Answer

The answer of Describe the characteristics of an efficient contract...

Question 15

In which of the following contracts is the agent's payment unaffected by his performance?
A) fixed-fee contract
B) hire contract
C) contingent contract
D) sharing contract

Accepted Answer

In a fixed-fee contract, the agent's payment is predetermined and not influenced by their performance. The other options involve some form of performance-based payment or commission.

Question 16

Season tickets entail a certain amount of risk due to unpredictable team quality,injuries,weather,and so forth.Who is most likely to purchase season tickets?
A) Sally, who is a rabid fan and is not wealthy
B) Jim, who is a rabid fan and is risk neutral
C) Roger, who is a rabid fan but is risk averse
D) Jenn, who is a fan and is very wealthy

Accepted Answer

Jim, being risk neutral, is most likely to purchase season tickets despite the risks involved because his attitude towards risk means he is neither overly cautious nor overly adventurous, making him more willing to accept the uncertainty that comes with season tickets.

Question 17

Moral hazard occurs when contracts are written in such a way that
A) the interests of agent and principal converge.
B) the interests of agent and principal diverge.
C) agents will wish to maximize the principal's utility.
D) production and risk-bearing efficiency are achieved.

Accepted Answer

Moral hazard is a situation where an agent has an incentive to take more risks or behave in a way that benefits them at the expense of the principal because they are shielded from the negative consequences of their actions. This is often the result when contracts are written in such a way that the interests of the agent and principal diverge.

Question 18

A key aspect of the principal-agent problem is that
A) the principal cannot perfectly monitor the agent's actions.
B) the principal can perfectly monitor the agent's actions.
C) the output level does not depend on the agent's actions.
D) the principal is always risk-averse.

Accepted Answer

The principal-agent problem occurs when the principal hires an agent to perform a task, but the agent's interests may not align with the principal's interests. The principal cannot perfectly monitor the agent's actions, which creates the potential for the agent to shirk or engage in opportunistic behavior. This information asymmetry can lead to moral hazard and adverse selection problems.

Question 19

In NASCAR,a race winner might win,say,$500,000,whereas second place wins $450,000.Why might NASCAR have a 10% reduction in prize money from first and second place?
A) To ensure that there is enough money to pay those who finish near last.
B) To motivate drivers to take risks they might not otherwise take.
C) To motivate drivers to not take risks they might otherwise take.
D) NASCAR is a cartel.

Accepted Answer

A 10% reduction in prize money from first to second place provides an incentive for drivers to take risks and push harder to try and secure the win, as the difference in payout is significant. Without this reduction, drivers may be more inclined to play it safe and settle for a lower, but still significant, payout for finishing in second.

Question 20

Explain how more than one possible state of nature affects contract choices.

Accepted Answer

The answer of Explain how more than one possible state...

Quiz 20: Contracts and Moral Hazards

Suppose an agent must pay the full marginal cost for an item but splits the marginal revenue with the principal.As a result,

Suppose the principal offers to share a percentage of the profit with the agent.Such a contract

In professional golf,a tournament winner might win,say,$1 million,whereas second place wins only $600,000.Why might golf have a 40% reduction in prize money from first and second place?

Season ticket holders often purchase their tickets before a season begins.There is often a discount associated with season tickets.Why?

Many professional sports athletes have incentive clauses in their contracts.These indicate that

Production efficiency implies that

What is one potential problem with nationalized health care?

Efficiency in risk bearing implies that

The type of contract selected depends on the information available to the parties.

In a store that sells souvenirs,suppose an agent receives a $1 commission for each unit sold,and the principal receives the residual profit.As a result,

We can say that a contract is able to prevent moral hazard when

The outcome of the state of nature effects the payoff to the agent under a

Production inefficiency is most likely to occur when the principal has more information about work performance than the agent does.

Describe the characteristics of an efficient contract between a principal and an agent.

In which of the following contracts is the agent's payment unaffected by his performance?

Season tickets entail a certain amount of risk due to unpredictable team quality,injuries,weather,and so forth.Who is most likely to purchase season tickets?

Moral hazard occurs when contracts are written in such a way that

A key aspect of the principal-agent problem is that

In NASCAR,a race winner might win,say,$500,000,whereas second place wins $450,000.Why might NASCAR have a 10% reduction in prize money from first and second place?

Explain how more than one possible state of nature affects contract choices.