Question 1

The seller of an existing house claims it is in great shape and offers a two-year warranty on the house.His statements about the quality of his house are

Accepted Answer

The warranty acts as a signal of quality because it would be costly for the seller to offer it if the house were not in great shape, making the claim more likely to be true.

Question 2

Statistical discrimination in the automobile insurance industry means that young male drivers who drive __________ will pay __________ rates relative to the number of claims they generate.

Accepted Answer

Statistical discrimination occurs when insurers use demographic factors, such as age and gender, to set rates. Young male drivers, even if they drive carefully, are statistically more likely to be involved in accidents, leading to higher rates relative to their actual claims.

Question 3

Two types of used Fender Stratocaster guitars are available for sale: those made in the U.S.and those made in Mexico.It is impossible for the buyer to know which is which,but the seller knows.The value of a U.S.Stratocaster is $900 and the value of a Mexican Stratocaster is $400.The U.S.Stratocasters are 30% of Fender's production and the Mexican Stratocasters are 70% of production.No seller must sell a guitar for less than the guitar's value.
-Refer to the information above.As time goes on,buyers' reservation prices will __________ and __________ U.S.-made Stratocasters will be offered for sale.

Accepted Answer

As buyers become more aware of the different values between the U.S. and Mexican Stratocasters, their reservation prices will likely fall. Additionally, since the value of a U.S. Stratocaster is higher, sellers may choose to hold onto them rather than sell them for a lower price, resulting in fewer U.S. Stratocasters being offered for sale.

Question 4

For which of the following occupations is the kind of car a person drives likely to be a good indication of their abilities?

Accepted Answer

In private practice, a doctor's car might reflect their success and financial status, which can be indirectly related to their abilities and reputation.

Question 5

Statistical discrimination occurs when

Accepted Answer

Statistical discrimination occurs when individuals are judged on the basis of the groups to which they belong. This is based on the assumption that certain characteristics or behaviors are associated with certain group memberships. For example, an employer might assume that all women are less committed to their careers because of their traditional roles as caregivers, leading them to discriminate against women in hiring or promotion decisions.

Question 6

Two types of used Fender Stratocaster guitars are available for sale: those made in the U.S.and those made in Mexico.It is impossible for the buyer to know which is which,but the seller knows.The value of a U.S.Stratocaster is $900 and the value of a Mexican Stratocaster is $400.The U.S.Stratocasters are 30% of Fender's production and the Mexican Stratocasters are 70% of production.No seller must sell a guitar for less than the guitar's value.
-Refer to the information above.Suppose that Fender discloses that a small stamp on the back of the guitar neck identifies its country of origin.Sellers of U.S.-made Stratocasters will now receive __________ because their claim of a U.S.-made Stratocaster is __________.

Accepted Answer

With the disclosure of the stamp, buyers can now confirm if a guitar is made in the U.S. or Mexico. Therefore, sellers claiming to sell a U.S.-made Stratocaster must provide evidence of the stamp, and buyers would be willing to pay at least $900 for a genuine U.S.-made guitar.

Question 7

Gus and Toby are both thrill seekers.Gus has life insurance and Toby does not.One can predict that

Accepted Answer

The answer of Gus and Toby are both thrill seekers.Gus...

Question 8

The lesson for consumers to learn from the lemons model is

Accepted Answer

The lesson for consumers to learn from the lemons model is that they should never expect a used car for sale to be of average or better quality. This is because the market for used cars is asymmetric, with sellers having more information about the car's true quality than buyers. As a result, higher-quality used cars are often kept off the market, while lower-quality "lemons" are more likely to be sold to unsuspecting buyers. Consumers should be aware of this information imbalance and take steps to protect themselves when buying a used car.

Question 9

Those most likely to purchase insurance against a negative event are those

Accepted Answer

Individuals who perceive themselves as having a higher risk of encountering a negative event are more inclined to purchase insurance to mitigate potential losses.

Question 10

Two types of used Fender Stratocaster guitars are available for sale: those made in the U.S.and those made in Mexico.It is impossible for the buyer to know which is which,but the seller knows.The value of a U.S.Stratocaster is $900 and the value of a Mexican Stratocaster is $400.The U.S.Stratocasters are 30% of Fender's production and the Mexican Stratocasters are 70% of production.No seller must sell a guitar for less than the guitar's value.
-Refer to the information above.The reservation price of a used Fender Stratocaster will be

Accepted Answer

The reservation price should be the average value of the two types of guitars weighted by their production percentages. So, the reservation price would be:

(0.3 x $900) + (0.7 x $400) = $270 + $280 = $550

Therefore, the best choice for the reservation price is B.

Question 11

The __________ it is for the buyer to assess the ________ of the used good,the __________ the lemons model will be.

Accepted Answer

According to the lemons model, the more difficult it is for a buyer to assess the quality of a used good, the less relevant the model will be. Therefore, the correct answer is C, as it states that the easier it is for the buyer to assess the quality, the less relevant the lemons model will be. Choice A is incorrect because it mentions "quantity" instead of "quality," and choice B is incorrect because it states that the more quality is assessable, the more relevant the model is. Choices D and E are incorrect because they contradict the logic of the lemons model.

Question 12

In order for the predictions of the lemons model to hold,it must be the case that

Accepted Answer

The answer of In order for the predictions of the...

Question 13

In general,the presence of insurance against the negative outcome of an event (e.g. ,fire insurance)tends to

Accepted Answer

The presence of insurance can lead to moral hazard, where individuals may take fewer precautions to prevent the event because they know they are financially protected.

Question 14

The seller of a used car claims this car is the most trouble-free car he has ever owned.This information

Accepted Answer

The claim may or may not be true, but it is not costly to fake. Therefore, it is possible that the seller is exaggerating, but also possible that the car has truly been trouble-free for them.

Question 15

Two types of used Fender Stratocaster guitars are available for sale: those made in the U.S.and those made in Mexico.It is impossible for the buyer to know which is which,but the seller knows.The value of a U.S.Stratocaster is $900 and the value of a Mexican Stratocaster is $400.The U.S.Stratocasters are 30% of Fender's production and the Mexican Stratocasters are 70% of production.No seller must sell a guitar for less than the guitar's value.
-Refer to the information above.Suppose that Fender discloses that a small stamp on the back of the guitar neck identifies its country of origin.As a result,

Accepted Answer

With the disclosure of the country of origin, buyers can now distinguish between U.S. and Mexican Stratocasters. This means that U.S.-made Stratocasters, which are more valuable, will be available for purchase as buyers can identify and are willing to pay their higher value.

Question 16

Suppose Linus purchased a new Lexus in 2003.Over time,he comes to discover it is of better-than-average quality.Therefore,

Accepted Answer

If Linus discovers that his Lexus is of better-than-average quality, he is less inclined to sell it because he values it more highly than an average car.

Question 17

The lemons model implies that

Accepted Answer

The lemons model suggests that the quality of used goods offered for sale is below average. This is because sellers with above-average quality goods have less incentive to sell, while sellers with below-average quality goods have a greater incentive to sell before buyers discover the low quality. Therefore, buyers are more likely to encounter lower quality goods in the market.

Question 18

Adverse selection refers to the idea that insurance is

Accepted Answer

Adverse selection occurs when those who are most likely to make a claim are more likely to purchase insurance. This leads to increased risk for the insurer and potentially higher premiums for all policyholders.

Question 19

Goods X and Y both have an average quality index of 50.For good X,the lowest quality is 45 and highest quality is 55.For good Z,the lowest quality is 25 and the highest quality is 75.One would predict that the lemons model will

Accepted Answer

The lemons model suggests that markets with a wider range of quality (like good Z with a range of 25 to 75) are more likely to suffer from information asymmetry, leading to adverse selection.

Question 20

Two types of used Fender Stratocaster guitars are available for sale: those made in the U.S.and those made in Mexico.It is impossible for the buyer to know which is which,but the seller knows.The value of a U.S.Stratocaster is $900 and the value of a Mexican Stratocaster is $400.The U.S.Stratocasters are 30% of Fender's production and the Mexican Stratocasters are 70% of production.No seller must sell a guitar for less than the guitar's value.
-Refer to the information above.If a buyer offers $550 and the offer is accepted,one can infer

Accepted Answer

The offer of $550 is closer to the value of a Mexican Stratocaster ($400), so it is likely that the seller accepted the offer for a Mexican Stratocaster. Therefore, the guitar was made in Mexico.

Quiz 11: The Economics of Information