Question 1

Which are social costs associated with the inability of shareholders to observe an executive's effort? (You may choose more than one.)
A)Excessive insurance offered.
B)The executive has to be exposed to risk to induce effort,and risk is costly.
C)The executive ends up exerting less than first-best effort.
D)Excessive effort induced.

Accepted Answer

C

Question 2

Adverse selection in competitive insurance markets harms
A)high-risk individuals.
B)low risk individuals.
C)owners of competitive insurance companies.
D)everyone.

Accepted Answer

Adverse selection leads to higher premiums, which disproportionately affects low-risk individuals who may opt out, leaving a riskier pool and further increasing premiums.

Question 3

Adverse selection arises in insurance markets because
A)insurance buyers have more information than insurance sellers.
B)insurance sellers have more information than insurance buyers.
C)individuals can select which insurance company to patronize.
D)insurance companies can exercise too much control over whom they insure.

Accepted Answer

Adverse selection occurs when one party in a transaction has more information than the other, typically the buyer having more information about their own risk levels than the seller. In insurance markets, this means individuals who are at higher risk are more likely to buy insurance, because they know more about their health status or risk factors than the insurance companies do.

Question 4

Which is a distortion (a loss of social surplus)associated with a monopolist's inability to observe consumer types when constructing a nonlinear pricing scheme?
A)The monopolist must expend more resources on market research.
B)All bundles involve inefficiently low quantities.
C)Some but not all bundles involve inefficiently low quantities.
D)Quantities aren't distorted,but prices extract too much consumer surplus.

Accepted Answer

When a monopolist cannot observe consumer types, it offers a menu of bundles to induce self-selection. Some consumers may end up with bundles that have inefficiently low quantities to prevent high-type consumers from mimicking low-type consumers, leading to a distortion in social surplus.

Question 5

How do participants in an auction respond to the problem of the "winner's curse"?
A)They bid more aggressively to win the auction and avoid the "curse".
B)They exit the auction because winning can only be a bad sign of the object's worth.
C)All bid less aggressively,so that the winner ends up not regretting having won.
D)The winner regrets having won the auction.

Accepted Answer

Participants in an auction typically respond to the problem of the "winner's curse" by bidding less aggressively. The "winner's curse" refers to the tendency for the winner of an auction to overpay for the item, leading to regret later on. By bidding less aggressively, the participants hope to avoid this regret and minimize the risk of overpaying. Therefore, option C is the most appropriate choice.

Question 6

Which of the following is an application of the moral-hazard problem?
A)a person buying insurance after a cancer diagnosis.
B)an salesperson who is not paid on commission being rude to customers.
C)coffee hounds buying the menu item meant for lower-demand consumers.
D)only inexperienced workers applying for a managerial job advertised with a relatively low salary.

Accepted Answer

The moral-hazard problem occurs when one party in a transaction has an incentive to take undue risks because the cost of those risks will be borne by another party. In option B, a salesperson who is not paid on commission may not have the incentive to be polite to customers because their income does not directly depend on sales, illustrating a moral-hazard problem where the employer bears the cost of the employee's lack of effort.

Question 7

Concerning auctions,what is the definition of a "common-values setting"?
A)Bids are submitted using open outcries.
B)Bids are submitted simultaneously,and the highest is selected as the winner.
C)Bidders value the object the same,but are uncertain as to what that value is.
D)Bids are submitted by syndicates of cooperating bidders.

Accepted Answer

A "common-values setting" refers to a situation where bidders value the object being auctioned in the same way but are uncertain as to what that value actually is. This uncertainty arises because the value is based on some common variable, such as the future price of a commodity, that is difficult to predict accurately. In such a setting, bidders must use their own information to estimate the common value and bid accordingly. This type of auction is often used for natural resource leases, where the value of the lease depends on the future price of the extracted resource.

Question 8

A risk-averse manager is hired to run a firm for shareholders. If the manager's effort can be observed and specified in a contract,which would be the best employment contract?
A)a high-powered incentive contract to elicit the most effort.
B)a fixed salary paid as long as the required effort is undertaken.
C)a proportion of profits paid as long as the required effort is undertaken.
D)a wage well in excess of his or her outside opportunity.

Accepted Answer

A risk-averse manager would prefer a fixed salary paid as long as the required effort is undertaken because this type of contract provides a stable income and eliminates the uncertainty associated with incentive contracts. A high-powered incentive contract would introduce risk and be less appealing to a risk-averse manager. While a proportion of profits is an attractive incentive, the variability of profits may be unappealing to a risk-averse manager. A wage well in excess of outside opportunities may be attractive, but it may not be necessary to elicit the required effort if the manager's effort can be specified in the contract. Therefore, a fixed salary paid as long as the required effort is undertaken is the best choice for a risk-averse manager.

Question 9

Which of the following is an application of the adverse-selection problem?
A)a customer driving more recklessly after buying car insurance.
B)a teenager "hanging out" with friends his or her parents do not approve of.
C)shareholders offering a high-powered incentive contract to a manager.
D)an auto repairman claiming that the repairs are more extensive than they actually are.

Accepted Answer

Adverse selection occurs when one party has more information than the other party in a transaction, resulting in the uninformed party making a decision based on incomplete or asymmetric information. In this case, the auto repairman has more information about the repairs needed, and can take advantage of the uninformed customer by falsely claiming that the repairs are more extensive than necessary.

Question 10

In the Spence education signaling model,what is the social value of education?
A)Employees improve their ability to perform on the job.
B)Employers can use education as a screen to match talented employees with high-skill jobs.
C)Employers can save the costs of on-the-job training,which is less efficient than a general education.
D)It allows low-ability employees to apply for high-salary jobs.

Accepted Answer

According to the Spence education signaling model, education serves as a signal to employers of an individual's abilities and motivation. Employers can then use education as a screening device to match talented employees with high-skill jobs. Thus, the social value of education is in providing an efficient mechanism for job matching and improving labor market efficiency.

Question 11

Given a series of contracts offered to an executive having the same slope (where slope refers to how the contract varies with changes in the firm's gross profits)but different intercepts (referring to the overall generosity of the contract). Which of these is not a consideration in figuring out which of these intercepts the shareholders would decide to build into the contract offered to the executive?
A)if too generous a contract is offered,this comes out of the firm's bottom-line profit.
B)if too generous a contract is offered,the executive may become lazy and not exert the required effort.
C)if the contract isn't generous enough,the executive will decide to work elsewhere.
D)if the contract isn't generous enough,only low-ability executives will apply.

Accepted Answer

The concern about the executive becoming lazy is more related to the structure of incentives rather than the generosity of the contract. The slope of the contract, which is the same for all options, would typically address the incentive to exert effort.

Question 12

The principal is distinct from the agent in the principal-agent model because
A)the principal offers the contract to the agent.
B)the principal is fully informed.
C)both a and b.
D)neither a nor b.

Accepted Answer

The principal offers the contract to the agent, which is a key distinction in the principal-agent model. The assumption that the principal is fully informed is not accurate; part of the challenge in these relationships often involves information asymmetry, where the agent may have more information about certain actions or outcomes than the principal.

Question 13

Which auction format generates the most revenue for the seller?
A)First price.
B)Second price.
C)They generate the same expected revenue.
D)Depends on the environment.

Accepted Answer

The revenue generated by an auction format can significantly depend on various factors such as the number of bidders, the value of the item being auctioned, the information available to the bidders, and the auction rules. Therefore, there is no one-size-fits-all answer, and the most revenue-generating auction format can vary depending on the specific environment or context.

Question 14

One way the "lemons problem" in the used-car market can be mitigated is by
A)raising the price of used cars.
B)hiring auto experts to sell used cars.
C)requiring sellers to guarantee trouble-free cars.
D)allowing owners to trade in their own cars when they purchase a used car.

Accepted Answer

Requiring sellers to guarantee trouble-free cars can mitigate the "lemons problem" by providing buyers with assurance and protection against purchasing a defective vehicle. This reduces the information asymmetry between buyers and sellers, as the seller is now taking on the risk rather than the buyer. It also provides an incentive for sellers to ensure they are selling a reliable vehicle, as they will be held accountable if the car breaks down soon after purchase.

Question 15

Suppose that your personal valuation for a painting is $200. Which auction format would induce you to bid more?
A)First price.
B)Second price.
C)You would bid the same in any format.
D)Depends on the environment.

Accepted Answer

The second price auction format would induce you to bid more because it creates an environment where you can bid your true valuation without fear of paying more than what you think the painting is worth. In a second price auction, the highest bidder wins but only pays the second highest bid amount. Therefore, if you bid $200 and another person bids $150, you would still win the auction but only pay $150. This incentivizes bidders to bid their true valuations because they won't have to pay more than the item is worth to them.

Question 16

A risk-averse manager is hired to run a firm for shareholders. If shareholders cannot observe the manager's effort,which would be the best employment contract?
A)a high-powered incentive contract to elicit maximum effort.
B)a fixed salary.
C)a moderately powered incentive scheme that elicits some effort without exposing the manager to too much risk.
D)an incentive scheme that provides maximum incentives and maximum insurance.

Accepted Answer

A moderately powered incentive scheme balances the need to motivate the manager to exert effort while not exposing them to excessive risk, aligning with the risk-averse nature of the manager.

Question 17

An example of adverse selection is
A)purchasing a new car sight unseen based on the recommendation of a neighbor.
B)high health-insurance premiums resulting from the poor health of people who buy policies.?
C)suppliers who charge more for better quality clothing than for lower quality clothing.
D)being talked into buying a low-quality item because the price is lower.

Accepted Answer

Adverse selection refers to a situation where one party in a transaction has more or better information than the other party, leading to the latter being disadvantaged. In this case, it refers to high health-insurance premiums resulting from the poor health of people who buy policies. The insurance company has less information about the health of these individuals and must charge higher premiums to cover the expected costs of healthcare.

Question 18

Which of the following are potential problems faced by a firm that wants to provide warranties for its lawnmowers? (Select all that apply.)
A)A moral hazard problem might arise,in that homeowners may be less careful with the mower,since they can always return it if it breaks.
B)The warranty may select for homeowners that don't have a lot of mowing to do,or have smooth lawns,because they won't have to pay as much for a warranty.
C)The warranty will increase demand by assuring customers of the product's quality.
D)The warranty will reduce demand because only makers of low-quality goods would need to reassure consumers in this way.

Accepted Answer

A moral hazard problem can occur when a warranty is provided because it reduces the incentive for homeowners to take care of the mower, knowing that they can return it if it breaks. This can lead to increased costs for the firm due to more frequent repairs or replacements.

Question 19

How is it logically possible for a monopolist to get different consumers to purchase different bundles on a menu (such as different sizes of coffee cups),and thereby achieve a form of price discrimination,even if the firm cannot observe the consumers' valuations directly?
A)Different types of consumers have different tradeoffs between money and amounts of the good.
B)The monopolist can use a market-separation strategy.
C)Social norms are powerful deterrents to lying about one's type.
D)This is impossible: if one bundle is preferred by one type,logically it will be preferred by all.

Accepted Answer

Different types of consumers have different tradeoffs between money and amounts of the good, allowing the monopolist to offer a menu of options that cater to these varying preferences, thus achieving price discrimination.

Question 20

A monopoly coffee shop is deciding on a menu of different cup sizes to sell to a population of consumers,some of whom are high demanders and some low demanders. How would the optimal menu differ depending on whether the consumers can be observably separated into the different types or not?
A)The menu is unaffected by type observability.
B)If types aren't observable,the large cup size should be increased to separate the high demander.
C)If types aren't observable,the small cup size should be increased to make it more attractive to low demanders.
D)If types aren't observable,the small cup size should be reduced to make it less attractive to high demanders.

Accepted Answer

If types aren't observable, the small cup size should be reduced to make it less attractive to high demanders, preventing them from choosing the low-demand option and ensuring self-selection.

Quiz 15: Asymmetric Information

Which are social costs associated with the inability of shareholders to observe an executive's effort? (You may choose more than one.)

Adverse selection in competitive insurance markets harms

Adverse selection arises in insurance markets because

Which is a distortion (a loss of social surplus) associated with a monopolist's inability to observe consumer types when constructing a nonlinear pricing scheme?

How do participants in an auction respond to the problem of the "winner's curse"?

Which of the following is an application of the moral-hazard problem?

Concerning auctions,what is the definition of a "common-values setting"?

A risk-averse manager is hired to run a firm for shareholders. If the manager's effort can be observed and specified in a contract,which would be the best employment contract?

Which of the following is an application of the adverse-selection problem?

In the Spence education signaling model,what is the social value of education?

The principal is distinct from the agent in the principal-agent model because

Which auction format generates the most revenue for the seller?

One way the "lemons problem" in the used-car market can be mitigated is by

Suppose that your personal valuation for a painting is $200. Which auction format would induce you to bid more?

A risk-averse manager is hired to run a firm for shareholders. If shareholders cannot observe the manager's effort,which would be the best employment contract?

An example of adverse selection is

Which of the following are potential problems faced by a firm that wants to provide warranties for its lawnmowers? (Select all that apply.)

How is it logically possible for a monopolist to get different consumers to purchase different bundles on a menu (such as different sizes of coffee cups) ,and thereby achieve a form of price discrimination,even if the firm cannot observe the consumers' valuations directly?

A monopoly coffee shop is deciding on a menu of different cup sizes to sell to a population of consumers,some of whom are high demanders and some low demanders. How would the optimal menu differ depending on whether the consumers can be observably separated into the different types or not?