Question 1

Mary Jo Smith is willing to work for $3,200 per month. She asks the HR manager at Plain Truth Advertising for $4,000 per month. While he was willing to pay $3,700 per month, he rejects her application and begins to search for a new employee again. This is an example of:
A) adverse selection.
B) value maximization.
C) bargaining failure.
D) agency incentive problems.

Accepted Answer

This scenario is an example of bargaining failure. Mary Jo and the HR manager were unable to come to an agreement on a salary, which led to the rejection of Mary Jo's application and the need for the HR manager to search for a new employee. This failure to reach a mutually beneficial outcome is a result of a breakdown in bargaining. Adverse selection would involve the HR manager hiring an employee who is not the best fit for the job, while value maximization and agency incentive problems do not accurately describe the situation presented.

Question 2

An informal understanding about the quality of product components is a key to the relationship between most companies and their suppliers. This a good example of:
A) an implicit contract.
B) an explicit contract.
C) a principal/agent conflict resolution.
D) an adverse selection problem.

Accepted Answer

An informal understanding about the quality of product components refers to an implicit contract, which is an unwritten agreement between two parties based on mutual trust and understanding. This type of contract relies on the parties' ability to communicate their expectations clearly and understand the other party's needs without resorting to formal legal documents.

Question 3

A pilot for a private jet stops for refueling in Omaha, Nebraska. Topper Fuels offers him a case of French wine to refuel with them (a total retail value of $324 to the pilot). For refueling, inspections, and minor repairs, Topper charges $2,700, $400 more than the least expensive fuel company. What has happened to the company that owns the private jet?

Accepted Answer

This is an example of an incentive conflict that is only possible because of asymmetric information. The owner of the private jet knows much less about the price of refueling in this market than the pilot that was hired. The pilot can take advantage of this in order to pick the refueling company that offers the pilot, not the owner of the private jet, the best deal. The combined welfare of the pilot and owner of the private jet is lower by $76 because while the pilot to $324 better off from the wine, the owner of the jet is $400 worse off.

Question 4

Billy Mac Tailor drives an eighteen-wheeler CG Carriers. He always stops at All Bright truck stops to by diesel fuel. He is a preferred customer and gets a free meal and shower worth $10.00. But All Bright charges $12.00 more for a fill up than most competitors. Which of the following is true?
A) CG Carriers gets a benefit of $22.00 because Tailor is a preferred customer.
B) CG Carriers has a wealth reduction of $2.00 even though they do not know about Tailor's actions.
C) There is a wealth transfer to Billy Mac Tailor and CG Carriers has a wealth reduction of $12.00 .
D) Billy Mac Tailor increases his income by $10.00 and CG Carriers also benefits.

Accepted Answer

By being a preferred customer, Billy Mac Tailor benefits from a free meal and shower worth $10.00. However, CG Carriers incurs a cost of $12.00 more for each fill up compared to most competitors. This results in a wealth transfer from CG Carriers to Billy Mac Tailor, with CG Carriers experiencing a wealth reduction of $12.00.

Question 5

Adverse selection in bargaining comes from:
A) lying to one party or another.
B) principals in the bargaining process.
C) agents in the bargaining process.
D) asymmetric information held by the principal or agent.

Accepted Answer

Adverse selection in bargaining arises from the situation where one party to a transaction has more information than the other, leading to information asymmetry. In this situation, the informed party (either the principal or the agent) has an advantage and can use this to their advantage in the negotiation process, leading to adverse selection. This can result in the uninformed party (usually the other party) making a decision that is not in their best interest.

Question 6

Always Round Tire hires Plain Truth Advertising to write copy for its newspaper advertisements. Always Round has a demand for advertising of MB = 400 -2S where S is the number of hours that Plain Truth delivers. If Plain Truth has a fixed supply cost: MC = $150 per hour, what are the number of hours that Always Round purchases from Plain Truth under the assumption of costless monitoring? How much is the contract worth to Always Round? If Always Round offers half of the surplus to Plain Truth as an incentive, how much is Plain Truth paid for the job?

Accepted Answer

The answer of Always Round Tire hires Plain Truth Advertising...

Question 7

A firm is focal point for a set of contracts. Explain the problems that (1) agency relationships, (2) asymmetric information, and (3) adverse selection can introduce to building a successful contract between two people.

Accepted Answer

The answer of A firm is focal point for a...

Question 8

What is an agency relationship? What are agency problems?

Accepted Answer

The answer of What is an agency relationship? What are...

Question 9

What are some ways of reducing adverse selection in the insurance market?

Accepted Answer

The answer of What are some ways of reducing adverse...

Question 10

J.T. Smith's company, Gamemaker, sells gambling equipment to gaming service companies. Since the quality of the equipment is difficult to monitor and gamblers are often the source of machine failure, Smith could cheat on the level of machine quality. However, Smith has a strong quality assurance program. A primary reason for that may be:
A) cost containment.
B) company reputation.
C) the need for reinforcement.
D) the asymmetric information Smith holds on quality.

Accepted Answer

The primary reason for Gamemaker's strong quality assurance program is likely their company reputation. If Smith were to cheat on the level of machine quality, it could damage the company's reputation and ultimately harm their business. By maintaining a strong quality assurance program, Gamemaker can ensure consistent and reliable equipment, which will help protect their reputation and maintain customer loyalty.

Question 11

J.T. Smith runs Gamemaker, an equipment producer for gaming service corporations. As CEO, Smith is seemingly worth $2.5 million per year in the marketplace. The directors are attempting to decide how to divide his compensation package between cash salary and perquisites. Using budget constraints and indifference curves, illustrate the potential outcomes for the Board of Directors.

Accepted Answer

The answer of J.T. Smith runs Gamemaker, an equipment producer...

Question 12

What is Adverse Selection? Give an example to illustrate this problem.

Accepted Answer

The answer of What is Adverse Selection? Give an example...

Question 13

Jim Range owns a Best Ice Cream store, one of 1,000 franchises across the country. Jim doesn't like to work evenings, so he hires Mary Jo Smith to work the store in the evening for $6.50 per hour. Mary Jo's friends come by each evening and she gives them free cones. Is this an adverse selection problem or an incentive problem? What is the solution?

Accepted Answer

The answer of Jim Range owns a Best Ice Cream...

Question 14

Always Round Tire hires Plain Truth Advertising to write copy for its newspaper advertisements. Always Round has a demand for advertising of MB = 400 -2S where S is the number of hours that Plain Truth delivers. If Plain Truth has a fixed supply cost: MC = $150 per hour, what are the number of hours that Always Round purchases from Plain Truth? Now, if the copy writers are slackers and only deliver 100 hours of work each week, and if the each company must spend $1,250 in monitoring and bonding costs, what is the surplus and residual loss in this environment?

Accepted Answer

The answer of Always Round Tire hires Plain Truth Advertising...

Question 15

While many managers and lawyers might claim that implicit contracts "aren't worth the paper that they are not written on," most understandings between companies and their customers and their employees are implicit. Why?

Accepted Answer

The answer of While many managers and lawyers might claim...

Question 16

While CEO of General Electric, Jack Welch was a very successful corporate manager. He also loaded up his retirement program with numerous unusual benefits such as rented apartments, free airplanes, and numerous club memberships. The owners (stockholders) were generally unaware of these benefits. This conflict between owners and managers involved:
A) choice of effort of Mr. Welch while he was CEO.
B) perquisite taking on the part of Mr. Welch.
C) differential risk exposure between Mr. Welch and the typical stockholder.
D) overinvestment in company offices by Mr. Welch.

Accepted Answer

The conflict between owners (stockholders) and managers, specifically Jack Welch, involved perquisite taking. Welch loaded up his retirement program with numerous unusual benefits that the owners were generally unaware of. This means that Welch was taking advantages or perquisites that were not disclosed to the owners or shareholders, which creates a conflict of interest.

Question 17

Incentive problems can be overcome, then it is in the interest of all parties to develop efficient solutions to agency problems. Through ______ , there will be more wealth to be shared among contracting parties.
A) adverse selection
B) value maximization
C) contracting until marginal benefit (MB) equals zero
D) asymmetric information

Accepted Answer

Value maximization is the process of creating as much value as possible for all parties involved in a transaction. By finding mutually beneficial solutions, all parties stand to gain more wealth. Adverse selection and asymmetric information are examples of agency problems that can make it difficult to achieve value maximization. Contracting until marginal benefit equals zero is a principle of economics that can guide decision-making but is not directly related to agency problems or the creation of value.

Question 18

Kaneshi Hartfield is a sales representative with Plain Truth Advertising. She is an excellent sales representative, but corporate management feels that she is too independent. But they are afraid to act, since Kaneshi maintains her own list of key contacts. This is an example of:
A) asymmetric information problems.
B) different time horizons of the sales representative and management.
C) the free rider problem.
D) the failure of bargaining.

Accepted Answer

Asymmetric information problems occur when one party has more or better information than the other, leading to an imbalance in a transaction or negotiation. In this case, Kaneshi's possession of a unique list of key contacts gives her more information and leverage over corporate management.

Question 19

Which of the following is not a problem in owner/manager (principal/agent) conflicts?
A) Choice of effort.
B) Perquisite taking.
C) Identical time horizons.
D) Differential risk exposure.

Accepted Answer

Identical time horizons is not a problem in owner/manager conflicts because it means that both the owner and the manager have the same time frame for achieving their goals, which can actually help reduce conflicts. The other options - choice of effort, perquisite taking, and differential risk exposure - are all common problems in these conflicts. Choice of effort refers to the manager's decision to work hard or slack off, which can impact the owner's profits. Perquisite taking occurs when a manager takes advantage of their position to receive benefits or perks that are not justified by their performance. Differential risk exposure refers to the fact that owners and managers may have different levels of risk tolerance, which can affect decision-making and lead to conflict.

Question 20

Monitoring costs are:
A) the costs of a failure in bargaining.
B) rarely incurred in contracts between a principal an agent.
C) the insurance costs of guaranteeing that the principal will not incur a cost of contract failure.
D) the costs of reviewing and overseeing the actions of an agent.

Accepted Answer

Monitoring costs refer to the expenses incurred by the principal to monitor the actions and performance of the agent to ensure that they are aligned with the principal's goals. These costs involve reviewing and overseeing the agent's work, providing feedback, and taking corrective measures if necessary. Hence, option D is correct, while options A, B, and C are not relevant to the concept of monitoring costs.

Quiz 10: Incentive Conflicts and Contracts

Mary Jo Smith is willing to work for $3,200 per month. She asks the HR manager at Plain Truth Advertising for $4,000 per month. While he was willing to pay $3,700 per month, he rejects her application and begins to search for a new employee again. This is an example of:

An informal understanding about the quality of product components is a key to the relationship between most companies and their suppliers. This a good example of:

Billy Mac Tailor drives an eighteen-wheeler CG Carriers. He always stops at All Bright truck stops to by diesel fuel. He is a preferred customer and gets a free meal and shower worth $10.00. But All Bright charges $12.00 more for a fill up than most competitors. Which of the following is true?

Adverse selection in bargaining comes from:

A firm is focal point for a set of contracts. Explain the problems that (1) agency relationships, (2) asymmetric information, and (3) adverse selection can introduce to building a successful contract between two people.

What is an agency relationship? What are agency problems?

What are some ways of reducing adverse selection in the insurance market?

What is Adverse Selection? Give an example to illustrate this problem.

While many managers and lawyers might claim that implicit contracts "aren't worth the paper that they are not written on," most understandings between companies and their customers and their employees are implicit. Why?

Incentive problems can be overcome, then it is in the interest of all parties to develop efficient solutions to agency problems. Through ______ , there will be more wealth to be shared among contracting parties.

Kaneshi Hartfield is a sales representative with Plain Truth Advertising. She is an excellent sales representative, but corporate management feels that she is too independent. But they are afraid to act, since Kaneshi maintains her own list of key contacts. This is an example of:

Which of the following is not a problem in owner/manager (principal/agent) conflicts?

Monitoring costs are: