Question 1

Refer to the graph above. Suppose that it is shows the market for an insurance product. If something happens to heighten the adverse selection problem in this market, then:

Accepted Answer

The answer of  Refer to the graph above. Suppose...

Question 2

In a well-functioning cap-and-trade system for pollution rights, the right to pollute will go to those who are able to acquire the largest net benefit from using the scarce resource "clean air".

Accepted Answer

In a cap-and-trade system, the allocation of pollution rights should be based on the ability of each user to obtain the largest net benefit from the use of clean air. This ensures that the resource is allocated efficiently and that those who need it the most are able to access it. Thus, those who can acquire the largest net benefit from clean air should have the right to pollute.

Question 3

The 2010 Health Care Reform Law, also known as "Obamacare", includes a part known as universal coverage which requires everyone to have health insurance. One reason for this is to address the problem of:

Accepted Answer

The requirement for universal coverage addresses the problem of adverse selection, where those with higher health risks are more likely to purchase insurance, leading to higher premiums for everyone. By requiring everyone to have insurance, the risk pool is expanded and premiums can be more affordable for everyone. Moral hazard is the tendency for people to take risks or make choices that they would not otherwise make because they are insured. Externalities are costs or benefits of a decision that affect other people or society as a whole. Public goods are goods or services that are non-excludable and non-rivalrous, meaning that they are available to everyone and one person's use does not diminish another's use.

Question 4

The moral hazard problem arises primarily because of:

Accepted Answer

Moral hazard occurs when one party has more information than the other and is able to take advantage of that information. Asymmetric information is the primary cause of moral hazard, as it allows one party to act in a way that benefits them at the expense of the other party. Individual bargaining, negative externalities, and poorly defined property rights can all contribute to economic inefficiency, but are not the primary cause of moral hazard.

Question 5

Asymmetric information in a market transaction occurs when there is unequal knowledge possessed by the:

Accepted Answer

Asymmetric information occurs when the buyer and the seller have unequal knowledge about the product or service being bought or sold. The government and taxpayer are not necessarily involved in the transaction, and therefore cannot have unequal knowledge. Therefore, the correct answer is D.

Question 6

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

Accepted Answer

While it may be desirable to eliminate all pollution, it may not be economically feasible or practical to do so. A more effective policy would be to identify the most harmful and costly sources of pollution and implement targeted measures to reduce them while considering the costs and benefits of each action. Additionally, some forms of pollution may be necessary for certain economic activities, and a complete ban could have negative economic impacts.

Question 7

Which of the following would be considered an example of adverse selection?

Accepted Answer

Adverse selection refers to the scenario where those who are most in need of a service or product (such as insurance) are also the ones most likely to seek it out. In the case of insurance, this may mean that individuals with pre-existing conditions or high-risk lifestyles are more likely to purchase insurance, leading to higher costs for the insurance provider. Choice C fits this definition, as it suggests that those most in need of insurance are the ones most likely to buy it.

Question 8

Which of the following would be an example of government intervention to correct a market failure caused by buyers having inadequate information about sellers?

Accepted Answer

Licensing of medical doctors and surgeons ensures that buyers (patients) have access to information about the qualifications and expertise of the seller (doctor or surgeon), thus correcting the market failure caused by inadequate information. This intervention helps to improve the quality of healthcare services and protect patients from harm.  The other options listed do not directly address the issue of inadequate information about sellers.

Question 9

If a person drives with less care after purchasing auto insurance, this situation would be an example of a(n):

Accepted Answer

The situation described is an example of moral hazard, which occurs when a person takes more risks or acts less responsibly because they are protected by insurance. The individual may think that any costs from an accident will be covered by their insurance, so they are less careful while driving. This increases the likelihood of accidents and raises costs for the insurance company.

Question 10

Because in any period of time and in any region the quantity of pollutants that can be absorbed by nature is fixed, the supply of "pollution rights" in a cap-and-trade system will be perfectly elastic.

Accepted Answer

The quantity of pollutants that can be absorbed by nature is not fixed and can vary depending on the location, time of year, and other factors. Therefore, the supply of pollution rights in a cap-and-trade system will not be perfectly elastic.

Question 11

Which of the following would be an example of a moral hazard problem?

Accepted Answer

Moral hazard occurs when one party takes greater risks or engages in dangerous behavior because they know that another party will be responsible for the financial consequences. In the case of reckless driving, the individual may be more likely to take risks since they know their auto insurance will cover any damages.

Question 12

Refer to the graph above. Suppose consumers do not know the safety risks associated with a particular good, and that the free-market equilibrium is at E as shown in the diagram above. If an independent agency now provides accurate information about the harmful characteristics of the product, then:

Accepted Answer

The answer of  Refer to the graph above. Suppose...

Question 13

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 14

When sellers are unable to distinguish "good" buyers from "bad" ones, they face the problem of:

Accepted Answer

Adverse selection occurs when one party (the seller) is unable to distinguish between "good" buyers and "bad" ones. This happens because the seller lacks information about the potential quality of the product or the buyer's ability to pay. As a result, the seller may be hesitant to sell to anyone due to the risk of getting a less than ideal buyer.

Question 15

Which of the following does not illustrate the asymmetric information problem:

Accepted Answer

Option C refers to uncertainty, which is different from the asymmetric information problem. The other options illustrate the asymmetric information problem, where one party has more information than the other, leading to potentially adverse outcomes.

Question 16

Insurance policies typically stipulate a deductible amount which the insured must shoulder; this is to address the problem of:

Accepted Answer

The use of a deductible in insurance policies is meant to combat the problem of moral hazard, which occurs when the presence of insurance causes an increase in risky behavior by the insured party because they no longer have to bear the full cost of any loss. The deductible requires the insured to share in the cost of the loss, thereby discouraging them from taking excessive risks. Adverse selection, externalities, and public goods are all different types of market failures that are typically addressed through other means.

Question 17

The "too big to fail" policy of the Fed, whereby some banks are bailed out if they are in danger of failing because they are too big and could bring the system down, leads to which of the following problems?

Accepted Answer

The "too big to fail" policy creates a moral hazard, where banks know they will be bailed out if in danger of failing, leading to potentially reckless behavior and further risks to the financial system.

Question 18

If Congress decreases the amount of government insurance on bank deposits, then this action would:

Accepted Answer

Decreasing the amount of government insurance on bank deposits would reduce the moral hazard problem. With less government insurance, banks would have less of a safety net if they engage in risky behavior. Therefore, they would be less likely to engage in such behavior, reducing the moral hazard problem.

Question 19

The franchising of fast-food restaurants would be an example of how a private business:

Accepted Answer

The franchising of fast-food restaurants allows the private business to overcome market information problems by leveraging the brand name, marketing strategies, and business model of the franchisor, which reduces the information asymmetry between the consumer and the franchisee. The franchisor provides a proven business model, supply chain, and marketing strategies to the franchisee, who in turn, pays a fee and a percentage of their revenue to the franchisor for the right to operate under their trademark and business model. This reduces the risks associated with starting a new business from scratch, such as market research, product development, branding, and advertising. Therefore, the franchising of fast-food restaurants is an example of how private businesses overcome market information problems.

Question 20

Refer to the graph above. Suppose consumers do not fully appreciate the benefits of the product whose market shown in the graph. If an external agency is able to provide full information about the benefits of the product, then:

Accepted Answer

If consumers do not fully appreciate the benefits of the product, then they may not demand as much of it at any given price. Thus, the demand curve would be lower than it would be if consumers fully understood the benefits. If an external agency is able to provide full information about the benefits of the product, then consumers' willingness to pay for it will increase, which will cause the demand curve to shift to the right. This will lead to a higher equilibrium price and quantity than before. Therefore, option B is the correct answer.

Quiz 4: Market Failures: Public Goods and Externalities