Question 1

In corporations,a principal-agent problem can arise when

Accepted Answer

A principal-agent problem can arise in any of these situations. Shareholders appoint managers to run the company on their behalf, but the managers may have different interests and goals than the shareholders, creating a conflict of interest. The board of directors also has a duty to act in the best interest of shareholders, but they may prioritize their own interests or the interests of the management team. Therefore, all of the above situations can create a principal-agent problem.

Question 2

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

Accepted Answer

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

Question 3

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

Accepted Answer

This is an example of adverse selection, where the seller has more information about the property's condition than the buyer, potentially leading to a transaction where the buyer is unaware of hidden defects.

Question 4

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

Accepted Answer

The requirement for a medical exam prior to writing an insurance policy is an example of screening, which helps the insurance company assess the risk of insuring an applicant by gathering information about their health status. This helps to prevent adverse selection, where individuals with higher risks of death or illness are more likely to seek out insurance, thereby increasing the company's costs.

Question 5

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

Accepted Answer

The statement of disclosure helps to address the adverse-selection problem by providing potential buyers with information on any known issues or defects with the property. This allows buyers to make informed decisions and reduces the risk of them unknowingly purchasing a property with costly problems.

Question 6

When a jeweler sells a low quality diamond to a young man who believes the diamond is the highest quality,she is engaging in

Accepted Answer

Adverse selection occurs when one party has more information than the other party, and in this case, the jeweler has more information about the quality of the diamond than the young man. Moral hazard occurs when one party takes risks because they are not fully responsible for the consequences of those risks, but there is no indication that this is happening in this scenario. Therefore, the best answer is D) adverse selection, but not moral hazard.

Question 7

Which of the following is not correct?

Accepted Answer

The statement is not always true. While the free market can help mitigate these problems, it is not a guarantee that they will be completely fixed. Government regulation and intervention may also be necessary to address adverse selection and moral hazard.

Question 8

The Latin term caveat emptor,meaning "let the buyer beware," brings to mind the problem of

Accepted Answer

The term "caveat emptor" suggests that the buyer is responsible for examining and evaluating the product or service before purchasing it. This highlights the issue of adverse selection, where the buyer must be cautious of potential hidden problems or risks associated with the purchase.

Question 9

Bill owns a small business in Milwaukee.He travels frequently,meeting with important customers,and attending conferences.Bill hired Nicole to work in the Milwaukee office as the day-to-day general manager of the business.

Accepted Answer

The situation described in the scenario is an example of a moral hazard problem because Nicole may not work as hard as Bill would like when she is not monitored. This is a common issue in situations where one party (in this case, Nicole) has more information or control over the outcome (the level of effort put into the business) than the other party (Bill).

Question 10

Adverse selection is

Accepted Answer

Adverse selection refers to the tendency for the mix of unobserved attributes to become undesirable from the standpoint of an uninformed party. This occurs when one party in a transaction has more information than the other party, leading to the uninformed party being stuck with a higher amount of risk or lower quality goods or services. For example, if a car salesman knows a used car has a hidden defect but does not disclose this information to the buyer, this creates adverse selection.

Question 11

Which of the following is an example of an adverse selection problem?

Accepted Answer

Adverse selection refers to a situation where one party has more information than the other party in a transaction. In this case, the man whose father had a heart attack has information about his family's health history that the insurance company does not have. This could lead to the insurance company offering him a policy at a higher premium or denying coverage altogether because they perceive him to be at a higher risk for heart disease.

Question 12

The buyer runs a risk of being sold a good of low quality when there is

Accepted Answer

When there is a problem involving hidden characteristics, the buyer is at risk of receiving a good of low quality because they do not have complete information about the product's attributes. This is also known as adverse selection. Examples include used cars, where the seller may not disclose all the defects or problems with the vehicle, or health insurance, where individuals with higher risks may be more likely to purchase insurance, leading to higher premiums for everyone.

Question 13

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

Accepted Answer

Tenure creates a situation of moral hazard where professors may become complacent and less motivated to perform well since they have job security. This decreases the incentive for the university to monitor their job performance closely.

Question 14

Adverse selection may lead to

Accepted Answer

Adverse selection can occur in various markets where one party has more information than the other, resulting in a "hidden information" problem. In the used car market, owners with information about the car's condition may be hesitant to sell it at a low price, which may signal to buyers that there is an issue with the car. In the labor market, job applicants with better skills may not apply for jobs with lower wages, resulting in unemployment. In the insurance market, individuals with low risk may choose to remain uninsured if the policies offered are priced too high to reflect their actual risk level. Therefore, all three choices are correct.

Question 15

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?

Accepted Answer

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

Question 16

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

Accepted Answer

Shareholders are the owners of the corporation and therefore they are principals, but they do not act as agents to manage the daily operations of the company. The board of directors and managers, on the other hand, are both principals and agents as they have decision-making power and can act on behalf of the corporation. Workers are not typically principals in a corporation as they do not have ownership or decision-making power.

Question 17

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?

Accepted Answer

Moral hazard leads to more claims as policyholders take more risks, resulting in higher premiums to cover increased payouts.

Question 18

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

Accepted Answer

A small family-owned business is usually operated by the owners and their immediate family members. In contrast, a corporation has a separation of ownership and control, which leads to a principal-agent problem. This means that the owners (shareholders) delegate decision-making power to managers, who may not always act in the best interest of the owners.

Question 19

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

Accepted Answer

This is an example of moral hazard as John is not using his time productively at work and is instead engaging in personal activities. Moral hazard refers to the situation where one party takes risks because they know they will not bear the full cost of those risks, and in this case, John is taking advantage of the fact that his employer is paying him for his time but he is not fully utilizing it for the benefit of the company.

Question 20

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?

Accepted Answer

This is an example of moral hazard, where one party (Joe) has a higher incentive to take risks because they do not bear the full consequences of their actions. In this case, Joe used poor-quality materials because he knew he would not be held accountable for the consequences as Carlos did not have enough knowledge about construction.

Quiz 22: Frontiers of Microeconomics