Question 1

Imperfect information among the potential bidders of a cable TV franchise results in a final bid that is more than the market value of a franchise. This situation is an example of:​

Accepted Answer

The winner's curse refers to a situation where the winning bidder in an auction overestimates the value of the asset they are bidding on due to imperfect information. This results in the winning bidder paying more than the asset's true market value. In this scenario, the potential bidders of a cable TV franchise have imperfect information, causing the winning bidder to overvalue the franchise and bid above its true market value. Therefore, the situation described in the question is an example of the winner's curse.

Question 2

Which of the following is true of the marginal benefit curve for additional information in Stigler's search model?​

Accepted Answer

Stigler's search model suggests that the marginal benefit of additional information is decreasing as the person acquires more information. This implies that the marginal benefit curve is downward sloping. The curve does not necessarily always lie above the marginal cost curve, and it does not begin at a point that represents full information or common knowledge.

Question 3

One result of asymmetric information in the market for bank loans is that:​

Accepted Answer

Asymmetric information in the market for bank loans can result in more bad loans than good loans being made because lenders might not have accurate information about the creditworthiness of borrowers. This can lead to lenders being more willing to make risky loans, which can increase the default rate.

Question 4

Individuals who have a tendency to default are usually more willing to pay high interest rates and thus get loans. This describes an example of:​

Accepted Answer

This situation describes adverse selection, where individuals with higher risk or propensity to default are more likely to seek out and accept high-interest loans, causing the lender to have a higher percentage of risky borrowers in their portfolio.

Question 5

The timeshare condominium in Florida bought by an individual last year ended up involving many extra costs and restrictions that were not apparent at the time of sale. This problem is a classic example of _____.​

Accepted Answer

The problem of extra costs and restrictions that were not apparent at the time of sale suggests that there were hidden characteristics involved in the transaction, which is a classic example of informational asymmetry. The buyer did not have all the relevant information before making the purchase, leading to an unfavorable outcome. This phenomenon is known as adverse selection or hidden characteristics. Therefore, option E is the correct choice. The other options are not applicable to this situation. The winner's curse occurs in auctions where the winner pays more than the item's worth. Moral hazard refers to the behavior of a party after a contract is agreed. Negative externalities involve the impact on third parties from economic activities. The principal-agent relationship involves how one person can act on behalf of another, often causing conflicts of interest.

Question 6

One result of asymmetric information in the market for used cars is that:​

Accepted Answer

Asymmetric information in the market for used cars means that the seller knows more information about the quality of the car than the buyer. This leads to the possibility of the seller selling lemons (low-quality cars) at a price that is higher than their market value. This is because the buyer cannot fully assess the quality of the car and may be willing to pay a higher price for a car that they believe to be good quality. As a result, more lemons may be offered for sale than good cars.

Question 7

The two types of asymmetric information situations are those with:​

Accepted Answer

Hidden characteristics refer to the situation where one party in the transaction possesses valuable information that the other party does not have, such as the quality of a product being sold. Hidden actions refer to the situation where one party in the transaction can take actions that are not observable by the other party, such as an employee shirking off work. Therefore, the answer is C, that is, hidden characteristics and hidden actions.

Question 8

The principal-agent problem arises because of:​

Accepted Answer

The principal-agent problem arises from hidden actions, which stem from the fact that the principal (such as a shareholder or owner) cannot fully observe or monitor the actions of the agent (such as a CEO or employee). This creates the potential for the agent to act in ways that are not in the best interest of the principal.

Question 9

In which of the situations described below is the principal-agent problem least likely to occur?​

Accepted Answer

The principal-agent problem is least likely to occur in the case of a bartender serving an individual at a bar because the service is straightforward and the interests of both parties are more aligned, with less information asymmetry compared to other scenarios.

Question 10

Which of the following results from the lemons problem observed in the market for used cars?​

Accepted Answer

The lemons problem results in a high ratio of lemons (low-quality cars) to high-quality cars in the market for used cars.

Question 11

The figure given below shows the marginal cost and the marginal benefit of information curves. In the figure given below, which of the following is likely to shift the marginal cost of information curve upward?​ ​
Figure 14.2

Accepted Answer

The answer of The figure given below shows the marginal...

Question 12

The winner's curse is more likely to occur when:​

Accepted Answer

The winner's curse is more likely to occur when the value of the good being auctioned is uncertain. This is because the winner of the auction is the bidder who overestimates the value of the good the most, resulting in them paying more than the true value. If the value of the good is known with certainty, bidders will not overestimate its value, and the winner's curse is less likely to occur.

Question 13

When individuals belonging to the informed side of a market self-select and harm those belonging to the uninformed side, the _____ problem occurs.​

Accepted Answer

Adverse selection occurs when individuals with more information self-select and cause harm to those with less information or knowledge. This often occurs in situations where high-risk individuals opt into insurance policies or when individuals with hidden health conditions apply for jobs. As a result, the uninformed parties end up paying a higher price or bearing most of the risk. The other options do not describe this particular situation.

Question 14

The used car market may be inefficient because the purchase of a used car often involves:​

Accepted Answer

The purchase of a used car involves hidden characteristics, such as the condition of the car, history of accidents or repairs, which are not easily observable or verifiable, leading to information asymmetry between the buyer and seller. This results in inefficiencies in pricing, quality, and selection.

Question 15

A refrigerator repairman charges Sandra for two hours of labor even though he could have fixed it in ten minutes. In this example, Sandra is facing the problem of:​

Accepted Answer

The answer of A refrigerator repairman charges Sandra for two...

Question 16

The publisher that paid Arthur James, a popular novelist, a $2 million advance on his recent novel, which sold only 42 copies, fell victim to:​

Accepted Answer

The situation described here is an example of the winner's curse, where the publisher paid a high advance to Arthur James assuming that the novel would be successful, but it turned out to be a complete failure. The publisher may have overestimated the value of the novel, leading to a situation where they paid too much for the rights to the book. This is a common problem in auctions and other settings where bidders may compete to acquire an asset or investment.

Question 17

In an auction, the winning bidder often ends up as an overly optimistic loser due to:​

Accepted Answer

The winning bidder may not have perfect information about the true value of the item being auctioned, leading them to bid too high and ultimately losing out due to overoptimism.

Question 18

If a seller has more information about the qualities and characteristics of a good than a buyer:​

Accepted Answer

The situation described is one of asymmetric information, where one party (the seller) has more information about the good than the other party (the buyer). This can lead to the buyer making a suboptimal decision, known as the problem of asymmetric information or adverse selection. The other options do not accurately describe this situation.

Question 19

When sellers have more information about the hidden characteristics of a good compared to buyers, more low-quality units are likely to be sold than high-quality units. This phenomenon is termed:​

Accepted Answer

The phenomenon described is known as the "lemons problem," where sellers with more information about the quality of goods compared to buyers may sell more low-quality units, leading to adverse selection. This is commonly seen in markets such as used cars or insurance, where sellers have more information about the condition of the product than buyers, leading to a decrease in the quality of goods sold.

Question 20

Which of these factors is likely to reduce search cost and price dispersion?​

Accepted Answer

Growth of information technology can help reduce search cost and price dispersion by making it easier and faster for consumers to gather information on prices and products. Additionally, it can facilitate the creation and operation of online marketplaces that allow for easier comparison shopping and price transparency. The other options are unlikely to have as much effect on search costs and price dispersion.

Quiz 14: Transaction Costs, Asymmetric Information, and Behavioral Economics

Imperfect information among the potential bidders of a cable TV franchise results in a final bid that is more than the market value of a franchise. This situation is an example of:

Which of the following is true of the marginal benefit curve for additional information in Stigler's search model?

One result of asymmetric information in the market for bank loans is that:

Individuals who have a tendency to default are usually more willing to pay high interest rates and thus get loans. This describes an example of:

The timeshare condominium in Florida bought by an individual last year ended up involving many extra costs and restrictions that were not apparent at the time of sale. This problem is a classic example of _____.

One result of asymmetric information in the market for used cars is that:

The two types of asymmetric information situations are those with:

The principal-agent problem arises because of:

In which of the situations described below is the principal-agent problem least likely to occur?

Which of the following results from the lemons problem observed in the market for used cars?

The figure given below shows the marginal cost and the marginal benefit of information curves. In the figure given below, which of the following is likely to shift the marginal cost of information curve upward? Figure 14.2

The winner's curse is more likely to occur when:

When individuals belonging to the informed side of a market self-select and harm those belonging to the uninformed side, the _____ problem occurs.

The used car market may be inefficient because the purchase of a used car often involves:

A refrigerator repairman charges Sandra for two hours of labor even though he could have fixed it in ten minutes. In this example, Sandra is facing the problem of:

The publisher that paid Arthur James, a popular novelist, a $2 million advance on his recent novel, which sold only 42 copies, fell victim to:

In an auction, the winning bidder often ends up as an overly optimistic loser due to:

If a seller has more information about the qualities and characteristics of a good than a buyer:

When sellers have more information about the hidden characteristics of a good compared to buyers, more low-quality units are likely to be sold than high-quality units. This phenomenon is termed:

Which of these factors is likely to reduce search cost and price dispersion?