Question 1

Which of the following is a characteristic of a corporation but not of a small family-owned business?
A)The corporation buys inputs in markets for the factors of production.
B)The corporation sells output in markets for goods and services.
C)The corporation is guided in its decisions by the objective of profit maximization.
D)The corporation faces a principal-agent problem created by the separation of ownership and control.

Accepted Answer

A small family-owned business is typically owned and controlled by one family, so there is no separation of ownership and control. Therefore, it does not face a principal-agent problem. In contrast, a corporation is owned by shareholders but controlled by managers, creating a principal-agent problem. The other options (A, B, and C) are characteristics of both corporations and small family-owned businesses.

Question 2

Kim owns a small business in Denver. She travels frequently, meeting with important customers, and attending conferences. Kim hired Matt to work in the Denver office as the day-to-day general manager of the business.
A)This is a moral hazard problem since Matt may not work as hard as Kim would like when he is not monitored.
B)Kim choosing to hire Matt is an example of adverse selection since it is possible that Matt will not work as hard as Kim expects.
C)Kim will most likely pay Matt a lower salary than normal since Kim will not be there to monitor Matt's work effort, and since Matt will not likely work hard knowing Kim cannot monitor his effort.
D)Kim is the agent and Matt is the principal.

Accepted Answer

The answer of Kim owns a small business in Denver....

Question 3

In corporations, a principal-agent problem can arise when
A)the shareholders are the principal and the managers are the agent.
B)the board of directors is the principal and the managers are the agent.
C)the shareholders are the principal and the board of directors is the agent.
D)All of the above are correct.

Accepted Answer

All three options describe possible principal-agent problems that can arise in corporations. Shareholders are the principal and managers or the board of directors can be the agent, and the board of directors is also a principal with managers as agents.

Question 4

Which of the following is not an example of an adverse selection problem?
A)A homeowner purchases a refrigerator that the seller knows has a history of leaking.
B)A highly productive worker quits her job after a salary cut knowing that she can make more at a different job.
C)A major league baseball player performs poorly in his second season after signing a multi-million dollar contract.
D)A contractor uses low quality materials for construction but charges for higher quality materials.

Accepted Answer

The performance of a major league baseball player is not necessarily related to adverse selection as it could be influenced by a variety of factors, including injury, training, or personal circumstances. Adverse selection refers to situations where one party has more information than the other and uses that information to their advantage, resulting in a transaction that is not beneficial for the less-informed party. Choices A, B, and D all involve a situation where one party has more information than the other and uses it to gain an advantage, leading to an adverse selection problem.

Question 5

A radio story reported a study on the makes and models of cars that were observed going through intersections in the Washington, D.C. area without stopping at the stop signs. According to the story, Volvos were heavily overrepresented; the fraction of cars running stop signs that were Volvos was much greater than the fraction of Volvos in the total population of cars in the D.C. area. This is initially surprising because Volvo has built a reputation as an especially safe car that appeals to sensible, safety-conscious drivers. How is this observation best explained?
A)Volvo drivers are not willing to take risks that they would take in another, less safe car. Driving a Volvo leads to a propensity to run stop signs.
B)Volvo drivers are not willing to take risks that they would take in another, less safe car. Driving a Volvo reduces the propensity to run stop signs.
C)Volvo drivers are willing to take risks that they would not take in another, less safe car. Driving a Volvo reduces the propensity to run stop signs.
D)Volvo drivers are willing to take risks that they would not take in another, less safe car. Driving a Volvo leads to a propensity to run stop signs.

Accepted Answer

The observation suggests that there may be a self-selection bias in the population of Volvo drivers. It is possible that individuals who are more prone to take risks or ignore rules are attracted to the safety features marketed by Volvo, leading to a higher propensity for running stop signs among Volvo drivers.

Question 6

Susan buys automobile insurance from Provident Insurance Company. If Susan avoids having an accident for three years, Provident will reduce the premiums she has to pay for her insurance. Nevertheless, she routinely drives while eating or texting and speeds up to try to make it through yellow lights.
A)This is an adverse selection problem which should be corrected with government intervention.
B)Susan is a principal and Provident is an agent in this principal-agent problem.
C)This is a moral hazard problem.
D)There is no way for Provident to determine whether Susan is a cautious or risky driver.

Accepted Answer

Susan's behavior of driving while distracted and speeding up to make it through yellow lights increases the likelihood of her getting into an accident, which can be considered a moral hazard problem. Provident may have difficulty determining Susan's true level of risk-taking behavior, but the fact that she engages in these risky behaviors is relevant to the insurance company's ability to assess and price the risk. This problem can potentially be mitigated through setting appropriate premiums based on risk-taking behavior or through measures such as using telematics to monitor driver behavior. There is no suggestion of adverse selection in this scenario, and the idea of principal-agent problem is not relevant to this particular example. Government intervention may not necessarily be required to address this problem, as market mechanisms for managing moral hazard can be effective.

Question 7

Insurance companies charge annual premiums to collect revenue, which they then use to pay customers who file claims for damages they incur. Because of the moral hazard problem insurance companies separate customers into groups. Group 1: customers who file few claims & Group 2: customers that file a lot of claims. After creating these groups, what happens to the average annual premium within a group?
A)Group 1: average annual premium increasesGroup 2: average annual premium increases
B)Group 1: average annual premium decreasesGroup 2: average annual premium increases
C)Group 1: average annual premium increasesGroup 2: average annual premium decreases
D)Group 1: average annual premium decreasesGroup 2: average annual premium decreases

Accepted Answer

The answer of Insurance companies charge annual premiums to collect...

Question 8

Adverse selection may lead to
A)owners of used cars choosing to keep them rather than sell them at the low price that skeptical buyers are willing to pay.
B)wages being stuck above the level that balances supply and demand, resulting in unemployment.
C)buyers with low risk choosing to remain uninsured because the policies they are offered fail to reflect their true characteristics.
D)All of the above are correct.

Accepted Answer

Adverse selection can occur in various markets and can lead to different outcomes such as the ones described in options A, B, and C. Therefore, all of the given choices are correct.

Question 9

When homeowners sell a house, part of the paperwork they complete is a statement of disclosure on which the homeowners are supposed to reveal everything that they know is wrong with the house. The purpose of the statement of disclosure is to try to solve the
A)principal-agent problem.
B)moral-hazard problem.
C)adverse-selection problem.
D)signaling problem.

Accepted Answer

The purpose of the statement of disclosure is to address the adverse-selection problem, which arises when buyers have less information than sellers about the quality of the house being sold. The statement of disclosure allows buyers to make more informed decisions about whether to purchase the property and how much to offer for it. The principal-agent problem relates to the challenges associated with aligning the interests of the homeowner (principal) and the real estate agent (agent) who is representing them in the sale. The moral-hazard problem relates to the risks associated with the homeowner taking actions that could harm the value of the property after the sale but before the transfer of ownership. The signaling problem relates to the challenges associated with conveying credible information to potential buyers about the quality of the property being sold.

Question 10

The fact that someone with information about a significant number of illnesses in their family history is likely to purchase health insurance is an example of
A)adverse selection.
B)monitoring.
C)moral hazard.
D)screening.

Accepted Answer

Adverse selection occurs when individuals with higher risks or costs are more likely to purchase insurance. In this case, someone with a significant family history of illnesses is likely to have a higher risk of becoming ill themselves, making them more likely to purchase health insurance.

Question 11

In corporations, which of the following are principals but not agents?
A)shareholders
B)the board of directors
C)managers
D)workers

Accepted Answer

Shareholders are the owners of the corporation and they elect the board of directors, which is the governing body that oversees management and makes major decisions on behalf of the company. Neither shareholders nor the board of directors act as agents of the corporation in day-to-day operations, unlike managers and workers who perform tasks on behalf of the company and can make decisions that bind the corporation.

Question 12

Suppose you are covered under health insurance or belong to a Health Maintenance Organization (HMO), and you are insured against all or most of the costs of visits to the doctor. As a result you are likely to make greater use of medical services of all kinds. This tendency of people with insurance to change their behavior in a way that leads to more claims against the insurance company is called
A)adverse selection.
B)moral hazard.
C)screening
D)signaling.

Accepted Answer

The tendency of people with insurance to change their behavior in a way that leads to more claims against the insurance company is called moral hazard. This is because people with insurance may take greater risks or be less careful about their health, knowing that their insurance will cover the costs of any resulting treatment. Adverse selection refers specifically to the situation where people with higher risks or health problems are more likely to buy insurance. Screening and signaling also relate to the issue of information asymmetry in insurance markets, where insurers may need to find ways to identify and differentiate between high- and low-risk customers.

Question 13

Insurance companies charge annual premiums to collect revenue, which they then use to pay customers who file claims for damages they incur. As a result of the moral hazard problem (1) what is the effect on the percentage of policy holders making claims, and (2) what is the effect on the average premium charged when compared to a world with no moral hazard problem?
A)The percentage of policy holders making claims is higher; average annual premiums are lower.
B)The percentage of policy holders making claims is lower; average annual premiums are lower.
C)The percentage of policy holders making claims is higher; average annual premiums are higher.
D)The percentage of policy holders making claims is lower; average annual premiums are higher.

Accepted Answer

The moral hazard problem occurs when people behave differently because they are insured, leading to an increase in the frequency and cost of claims. This means that more policyholders will be likely to make claims, driving up the percentage of claims filed. As a result, insurance companies will need to charge higher premiums to cover the increased costs, leading to higher average annual premiums. Therefore, the correct answer is C.

Question 14

Adverse selection is
A)the tendency of a person who is imperfectly monitored to engage in dishonest or otherwise undesirable behavior.
B)an action taken by an uninformed party to induce an informed party to reveal information.
C)the failure of majority voting to produce transitive preferences for society.
D)the tendency for the mix of unobserved attributes to become undesirable from the standpoint of an uninformed party.

Accepted Answer

Adverse selection is the tendency for the mix of unobserved attributes to become undesirable from the standpoint of an uninformed party. This can occur in various situations, such as insurance markets, where those who are more likely to have claims may be more likely to purchase insurance.

Question 15

Which of the following is not correct?
A)An example of adverse selection is man who tries to sell his used car without disclosing that it needs a new transmission.
B)The "invisible hand" of a free market will always fix the problems of adverse selection and moral hazard.
C)An employer may try to prevent a moral hazard problem by paying her workers an efficiency wage.
D)One interpretation of gift giving is that it reflects asymmetric information and signaling.

Accepted Answer

The statement that the "invisible hand" of a free market will always fix the problems of adverse selection and moral hazard is not correct. While free markets can help alleviate some problems, they are not a guaranteed solution to all market failures. Adverse selection and moral hazard may persist or worsen in certain market conditions.

Question 16

Which of the following is a plausible explanation for a firm paying above-equilibrium wages to its workers?
A)It increases the probability that a worker who shirks will be caught.
B)It discourages workers from shirking out of fear of losing their high-paying job.
C)The Condorcet Paradox suggests that paying high wages will result in greater effort by employees.
D)By paying a high wage, employers solve this adverse selection problem and motivate the employees to work harder.

Accepted Answer

By paying above-equilibrium wages, a firm can discourage workers from shirking out of fear of losing their high-paying job. This is known as the "efficiency wage theory."

Question 17

When a night watchman only performs two walk-throughs per night when he is being paid to perform five walk-throughs per night, it is an example of
A)both moral hazard and adverse selection.
B)neither moral hazard nor adverse selection.
C)moral hazard, but not adverse selection.
D)adverse selection, but not moral hazard.

Accepted Answer

This is an example of moral hazard, where the night watchman is shirking his responsibilities since he knows he won't face any consequences for not doing his job properly. There is no indication of adverse selection being a factor in this situation.

Question 18

Steve borrowed some money from Summit Bank, telling the loan officer that he intended to use the money to remodel his restaurant. After getting the loan, Steve and his girlfriend immediately took the money and went gambling in Vegas.
A)This is an example of adverse selection since banks have difficulty selecting their customers.
B)This example does not involve asymmetric information.
C)From the given information, Steve is the principal and Summit Bank is the agent.
D)None of the above are correct.

Accepted Answer

The answer of Steve borrowed some money from Summit Bank,...

Question 19

Adverse selection
A)occurs when the overall quality of choices facing a consumer is very low.
B)is a greater problem for employees than employers.
C)occurs more frequently in the market for new cars than used cars.
D)is not easily remedied by free markets.

Accepted Answer

Adverse selection refers to the tendency for people with higher risks or costs to be more likely to buy insurance or enter into contracts, which can lead to a deterioration of the overall quality of the pool of insured or contracted parties. This is not easily remedied by free markets as it requires the presence of specialized knowledge or inside information to properly assess risks and costs, which may not be available or easily obtained by all parties in the market.

Question 20

In corporations, which of the following are agents but not principals?
A)shareholders
B)the board of directors
C)managers
D)workers

Accepted Answer

The answer of In corporations, which of the following are...

Quiz 22: Frontiers in Microeconomics

Which of the following is a characteristic of a corporation but not of a small family-owned business?

Kim owns a small business in Denver. She travels frequently, meeting with important customers, and attending conferences. Kim hired Matt to work in the Denver office as the day-to-day general manager of the business.

In corporations, a principal-agent problem can arise when

Which of the following is not an example of an adverse selection problem?

Adverse selection may lead to

When homeowners sell a house, part of the paperwork they complete is a statement of disclosure on which the homeowners are supposed to reveal everything that they know is wrong with the house. The purpose of the statement of disclosure is to try to solve the

The fact that someone with information about a significant number of illnesses in their family history is likely to purchase health insurance is an example of

In corporations, which of the following are principals but not agents?

Adverse selection is

Which of the following is not correct?

Which of the following is a plausible explanation for a firm paying above-equilibrium wages to its workers?

When a night watchman only performs two walk-throughs per night when he is being paid to perform five walk-throughs per night, it is an example of

Steve borrowed some money from Summit Bank, telling the loan officer that he intended to use the money to remodel his restaurant. After getting the loan, Steve and his girlfriend immediately took the money and went gambling in Vegas.

Adverse selection

In corporations, which of the following are agents but not principals?