Question 1

Steve is planning to sell his home.In preparation for the sale,he paints all of the ceilings in his house to cover up water stains from his leaking roof so that potential buyers will be unaware of this problem.This is an example of
A)moral hazard.
B)screening.
C)adverse selection.
D)the principal-agent problem.

Accepted Answer

The answer of Steve is planning to sell his home.In...

Question 2

When new professors are hired,their job performance is monitored closely.If they meet their institution's standards,they will eventually receive tenure.After receiving tenure,professors' job performance is less closely monitored,and they become difficult to fire.Tenure thus creates
A)adverse selection.
B)a Condorcet paradox.
C)a screening problem.
D)moral hazard.

Accepted Answer

Tenure creates a moral hazard because professors who have job security may become less motivated to perform well or work hard. They cannot be easily fired, so there is less pressure for them to maintain high job performance.

Question 3

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 percentage of policy holders making claims,and (2)what is 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 answer of Insurance companies charge annual premiums to collect...

Question 4

Moral hazard occurs when
A)an employer closely monitors an employee.
B)two people consider a trade with each other and one person has relevant information about some aspect of the product's quality that the other person lacks.
C)an employee lacks an incentive to promote the best interests of the employer, and the employer cannot observe the actions of the employee.
D)an employee closely monitors the actions of their employer.

Accepted Answer

Moral hazard occurs when an employee lacks an incentive to promote the best interests of the employer, and the employer cannot observe the actions of the employee. This can cause the employee to take risks or engage in actions that may benefit themselves at the expense of the employer.

Question 5

Joe's Computers builds and sells computers for the local retail market.Since Joe's business does not have the name recognition of some of the bigger computer retailers,Joe advertises a "One-Year Money Back Guarantee" to indicate to buyers that his product is of high quality.This guarantee is an example of
A)screening.
B)signaling.
C)the seller's curse.
D)the principal-agent problem.

Accepted Answer

The "One-Year Money Back Guarantee" is a signaling mechanism used by Joe to convey his product's high quality to potential buyers. This guarantee serves as a signal that Joe's Computers is confident in the quality of their product, and is willing to provide a monetary incentive to back up that claim.

Question 6

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

This observation could be best explained by the possibility that Volvo drivers, feeling protected by the car's safety features, are more willing to take risks that they would not have taken in another less safe car, leading to a propensity to run stop signs.

Question 7

Suppose that you major in physics because potential employers perceive that it is harder than other majors.Assuming education has no real value,your majoring in physics provides potential employers with
A)a signal.
B)a screen.
C)a potential moral hazard.
D)a potential adverse selection.

Accepted Answer

Majoring in physics is a signal to potential employers that you have a high level of intelligence, work ethic, and analytical skills, which are valuable qualities in the job market. It indicates that you are capable of handling difficult challenges and have a passion for science and technology. Education does have real value, and a physics degree can open doors to high-paying and challenging careers in fields such as engineering, research, and technology development.

Question 8

Which of the following is an example of signaling?
A)John is considering the purchase of a used car.Before making the purchase he has the car checked by an auto mechanic.
B)Steve is applying for a new life insurance policy.Before writing the policy, the insurance company requires Steve to be examined by a doctor.
C)Traci is applying for a new job.Before hiring her, the firm requires Traci to take a drug test.
D)Ray is planning to ask for Honna's hand in marriage.Before asking her, he buys her a box of her favorite chocolates and takes her to dinner at her favorite restaurant.

Accepted Answer

Ray is using a signal, in the form of buying Honna's favorite chocolates and taking her to her favorite restaurant, to indicate his intention of proposing marriage to her. This signal communicates his feelings and intentions towards her. Choices A, B, and C are examples of screening or selection, rather than signaling.

Question 9

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)Condorcet paradox.
B)moral hazard.
C)screening
D)signaling.

Accepted Answer

The tendency of people with insurance to change their behavior and make greater use of medical services of all kinds is known as moral hazard. This is because the insurance policy reduces the financial risk for the person, leading them to take actions that they would not have taken if they were not insured. This behavior can result in more claims against the insurance company, leading to higher premiums for everyone in the insurance plan.

Question 10

The fact that someone with a high risk of medical problems is likely to buy a large amount of health insurance is an example of
A)adverse selection.
B)monitoring.
C)moral hazard.
D)screening.

Accepted Answer

Adverse selection refers to when individuals who are at a higher risk of needing or using a certain service or product (in this case, health insurance) are more likely to purchase it. This can lead to higher costs for the insurance company, as they are providing coverage for a riskier population.

Question 11

A life insurance company requires new applicants to have a medical exam prior to writing the insurance policy.This requirement is an example of
A)signaling.
B)screening.
C)moral hazard.
D)adverse selection.

Accepted Answer

This requirement is an example of screening, where the life insurance company is using the medical exam to gather information on the applicant's health in order to assess the level of risk associated with providing insurance coverage. By doing so, the company can more accurately price the policy and avoid adverse selection.

Question 12

John goes to work 8 hours per day,but while he is at work he spends most of his time visiting internet sites that provide him with information on his favorite hobby.This is an example of
A)the Condorcet Paradox.
B)signaling.
C)moral hazard.
D)screening.

Accepted Answer

This is an example of moral hazard because John is not performing his job duties and is instead using work time for his own personal interests. This behavior is made possible because John does not bear the full cost of his actions (loss of productivity), and as a result, is exhibiting moral hazard.

Question 13

ABC Inc.is concerned about the work effort of its employees.To minimize this problem,which of the following would be an effective policy for ABC to implement?
A)Pay the employees a wage in excess of the wage the employees would earn elsewhere.
B)Secretly install videocameras to monitor employees, and fire employees who shirk their responsibilities.
C)Eliminate profit-sharing programs since these tend to give employees the incentive to shirk their duties until the year-end bonus is paid.
D)Both a and b are correct.

Accepted Answer

Both A and B are effective policies to minimize the problem of employee shirking. Paying employees a wage in excess of the wage they would earn elsewhere (A) reduces the incentive to shirk since employees are less likely to leave their jobs for a lower-paying position. Secretly installing video cameras to monitor employees and firing employees who shirk their responsibilities (B) also reduces the incentive to shirk since employees are more likely to be caught and punished if they do not work hard.

Question 14

Carlos,who knows nothing about construction,paid Joe to remodel a room in his house.Two years later,one wall in the remodeled room crumbled because Joe used poor-quality materials.This illustrates which economic problem?
A)Adverse selection
B)Screening
C)Moral hazard
D)Signaling

Accepted Answer

This is an example of moral hazard, which occurs when one party (in this case, Joe) has more information or control over a situation than the other party (Carlos) and therefore takes risks or engages in irresponsible behavior that negatively affects the other party. Joe had no incentive to use high-quality materials because he knew that Carlos did not have the knowledge or expertise to identify or prevent him from doing so.

Question 15

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 refers to the tendency for a mix of unobserved attributes (such as health risks, driving record, or credit history) to become undesirable from the standpoint of an uninformed party (such as an insurance company or lender). In this situation, those with higher risk or poor credit history are more likely to seek out insurance or loans, leaving the uninformed party with a higher proportion of riskier individuals in their pool, leading to increased costs or losses for the uninformed party.

Question 16

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 increases
Group 2: average annual premium increases
B)Group 1: average annual premium decreases
Group 2: average annual premium increases
C)Group 1: average annual premium increases
Group 2: average annual premium decreases
D)Group 1: average annual premium decreases
Group 2: average annual premium decreases

Accepted Answer

Insurance companies use a risk-based approach to setting premiums, which means that customers who file more claims are seen as higher risk and will likely face higher premiums. Therefore, Group 2, consisting of customers who file a lot of claims, will likely see an increase in their average annual premium. On the other hand, Group 1, consisting of customers who file few claims, will likely see a decrease in their average annual premium.

Question 17

When a potential client enters a lawyer's office,they want to observe expensive furniture and art work because
A)these items are items that the lawyer displays to new clients in an attempt to signal her quality.
B)these items are expensive and they provide a screening of the quality of the lawyer.
C)these items are an example of eliminating a moral hazard.
D)these items are a signal of the lawyer's adverse selection.

Accepted Answer

Expensive furniture and artwork are used by lawyers to signal their quality and success to potential clients, indicating that they are capable and trustworthy.

Question 18

Moral hazard is a problem in which it is difficult to observe a
A)hidden characteristic.
B)hidden action.
C)hidden budget constraint.
D)hidden set of preferences.

Accepted Answer

Moral hazard occurs when one party is protected from the consequences of their risky behavior or actions, which can lead to a change in their behavior. This change in behavior can be difficult to observe, as it is not always evident whether the individual is taking risks or is behaving responsibly. Therefore, the problem of moral hazard arises from hidden actions, making choice B the correct answer.

Question 19

In view of the possible need for government action in markets where asymmetric information is a problem,which of the following is a valid concern?
A)The government almost always has more information than the private parties.
B)Private markets have no means of dealing with information asymmetries on their own.
C)The government is itself an imperfect institution.
D)Legally, the government can rarely intervene in markets.

Accepted Answer

The concern about the government's ability to intervene in markets where asymmetric information is a problem is valid, as the government is itself an imperfect institution. This means that there is a risk that government action may not be effective or may create unintended consequences. Option A is incorrect as the statement is not always true. Option B is also incorrect, as private markets may be able to develop their own mechanisms to deal with information asymmetries, such as reputation systems or industry self-regulation. Option D is incorrect as the government does have legal means to intervene in markets, although the extent of this intervention may be limited by political and legal constraints.

Question 20

Asymmetric information is a problem that
A)always arises from government intervention in private markets.
B)serves as a possible rationale for government intervention in private markets.
C)always amounts to a moral-hazard problem.
D)forced economists to break the field of economics into two sub-fields: microeconomics and macroeconomics.

Accepted Answer

Asymmetric information refers to a situation where one party in a transaction has more information than the other party. This leads to the potential for one party to take advantage of the other. It is a problem that can arise in both private and government markets. Government intervention can be a possible solution to address the information asymmetry and protect consumers.

Quiz 22: Frontiers of Microeconomics

Steve is planning to sell his home.In preparation for the sale,he paints all of the ceilings in his house to cover up water stains from his leaking roof so that potential buyers will be unaware of this problem.This is an example of

When new professors are hired,their job performance is monitored closely.If they meet their institution's standards,they will eventually receive tenure.After receiving tenure,professors' job performance is less closely monitored,and they become difficult to fire.Tenure thus creates

Moral hazard occurs when

Suppose that you major in physics because potential employers perceive that it is harder than other majors.Assuming education has no real value,your majoring in physics provides potential employers with

Which of the following is an example of signaling?

The fact that someone with a high risk of medical problems is likely to buy a large amount of health insurance is an example of

A life insurance company requires new applicants to have a medical exam prior to writing the insurance policy.This requirement is an example of

John goes to work 8 hours per day,but while he is at work he spends most of his time visiting internet sites that provide him with information on his favorite hobby.This is an example of

ABC Inc.is concerned about the work effort of its employees.To minimize this problem,which of the following would be an effective policy for ABC to implement?

Carlos,who knows nothing about construction,paid Joe to remodel a room in his house.Two years later,one wall in the remodeled room crumbled because Joe used poor-quality materials.This illustrates which economic problem?

Adverse selection is

When a potential client enters a lawyer's office,they want to observe expensive furniture and art work because

Moral hazard is a problem in which it is difficult to observe a

In view of the possible need for government action in markets where asymmetric information is a problem,which of the following is a valid concern?

Asymmetric information is a problem that