Week-6 Practice Questions
From whom would you prefer to buy a used car, everything else being equal?
Question 1 options:
A used-car dealer.
A family that is moving to China.
A person who is buying a new car.
You would have no preference among these choices.
Suppose that in Milford, Connecticut, owners of used cars that are lemons value their cars at $2,500, and owners of used cars that are reliable value their cars at $6,000. There are equal quantities of each type of car on the market. Buyers value low-quality cars at $1,500 and high-quality cars at $7,000. In this market:
Question 2 options:
only low-quality cars will be sold at a price of $1,500.
only low-quality cars will be sold at a price of $2,500.
all cars will sell at a price of $4,250.
only high-quality cars will be sold at a price of $6,000.
only high-quality cars will be sold at a price of $7,000.
Suppose the Ajax Insurance Company provides insurance for skydivers whose wealth before diving is $400. An accident will leave divers with a wealth of $100. The company divides the divers into two classes, safe (probability of an accident = 0.2) and unsafe (probability of an accident = 0.5). The utility of wealth for all divers is given by the function: U(w) = w0.5. Given this information, the divers are:
Question 3 options:
indifferent to risk.
risk-averse, risk seeking, or risk-neutral; we cannot tell from this information.
Good drivers have a 20% chance, and bad drivers have a 50% chance, of getting into an accident. A car is worth $900, and an accident would reduce its value to $400. Both types of drivers have utility U = (car value)0.5. What is a bad driver’s expected utility without insurance?
Question 4 options:
None of the above.
Suppose the Ajax Insurance Company provides insurance for skydivers whose wealth before diving is $400. An accident will leave divers with a wealth of $100. The company divides the divers into two classes: safe (probability of an accident = 0.2) and unsafe (probability of an accident = 0.5). The utility of wealth for all divers is given by the function: U(w) = w0.5. The utility of no insurance for the safe diver is:
Question 5 options:
none of the above.
Good drivers have a 20% chance, and bad drivers have a 50% chance, of getting into an accident. A car is worth $900, and an accident would reduce its value to $400. Both types of drivers have utility U = (car value)0.5. What is a good driver’s expected utility without insurance?
Question 6 options:
None of the above.
Which of the following is the best example of adverse selection?
Question 7 options:
Smokers are more likely to obtain health insurance.
Safe drivers tend to get auto insurance.
All drivers are required to have auto insurance if they are to register their cars legally in Connecticut.
Both healthy and unhealthy people tend to buy life insurance.
Given the existence of government-funded flood insurance, people continue to build homes in floodplains.
Most states require car owners to provide evidence that they have auto insurance when they register their cars and obtain license plates. For the sellers of insurance policies, this may help to limit the severity of the:
Question 8 options:
moral hazard problem.
adverse selection problem.
Optimal employment contracts for managers, given revenue risk and unobservable output, consist of:
Question 9 options:
a flat salary alone.
a flat salary plus some return to estimates of effort.
only a profit share.
a flat salary plus a profit share related only indirectly to individual effort.
a flat salary plus a profit share that is equal to the share accruing to owners.
The savings and loan crisis of the early 1990s was caused by a moral-hazard problem because:
Question 10 options:
government insurance encouraged bank managers to take on more risk than they would have without such insurance.
bank managers no longer attempted to maximize the profits of the firm.
insurance attracted depositors who would not have used banks otherwise.
depositors had more information about the banks than shareholders had.
government insurance encouraged bank managers to take on less risk than they would have without such insurance.
Consider Mr. Ed, who purchases an insurance policy on a thoroughbred that he has acquired. He then proceeds to run the horse even though the horse has tendinitis. This is an example of:
Question 11 options:
an adverse-selection problem.
a moral-hazard problem.
all the above.
In recent years, individuals and state governments have sued various tobacco companies to compensate for illness and injury allegedly caused by cigarette smoking. Courts have awarded millions of dollars to victims in these cases. This product liability law:
Question 12 options:
encourages firms to ignore safety issues when developing products.
creates an incentive incompatibility between producers and consumers.
encourages incentive compatibility between producers and consumers.
is the only way to achieve compatible incentives when consumer safety is at issue.
forces firms to declare bankruptcy and to default on bondholders.
In insurance markets, moral hazard occurs when the behavior of
Question 13 options:
A) the insurer changes in a way that raises costs for the insured person, since the insurer no longer bears the full costs of that behavior.
B) the insured person changes in a way that eliminates rising health care costs for the insurer, since the insured person no longer bears the full costs of that behavior.
C) the insured person has an incentive to under consume medical services, simply because the insured person no longer bears the full cost of medical services.
D) the insured person changes in a way that raises costs for the insurer, since the insured person no longer bears the full costs of that behavior.
As a result of moral hazard
Question 14 options:
A) physicians and hospital administrators have no incentive to raise costs.
B) both physicians and hospitals have a financial interest in trying to keep hospital costs down.
C) both physicians and hospitals order more procedures.
D) patients increasingly have to worry about the expense of operations and other medical procedures.
In the market for used cars, if buyers and sellers have perfect information about the quality of cars, then
Question 15 options:
all cars will sell for the same price and there is no asymmetric information problem.
all cars will sell for the same price and there is an asymmetric information problem.
cars sell for their true value and there is no asymmetric information problem.
all cars will sell for the same price and there is a moral hazard problem.
A firm that can sell essentially the same product with the same quality under different brand names that have different perceived quality, the firm
Question 16 options:
has a moral hazard problem.
creates noise in the market.
creates an arbitrage opportunity.
is engaging in unfair trading practices.
If some consumers think that two detergents have differing qualities, such as brand-name vs. private label detergents, wheres other consumers know that the detergents are identical, then the detergent producer can
Question 17 options:
reduce its costs.
engage in a special type of price discrimination.
avoid moral hazard.
None of these.
Firms are able to price discriminate
Question 18 options:
when all customers are uninformed about quality differences.
when no customers are uninformed about quality differences.
when some customers are uninformed about quality differences.
when there is full information about quality available to all customers.
Selling the same product under different brand names allows a firm to price discriminate as long as
Question 19 options:
customers know the products are identical.
customers do not know the products are identical.
the products really are not the same.
the firm lets customers know that the products are identical.
Firms that seek to avoid hiring lazy workers that assert they are hardworking are trying to avoid
Question 20 options:
Assume Health Insurance is provided universally by the government. This would
Question 21 options:
eliminate the problems of adverse selection.
result in adverse selection.
eliminate the problems of moral hazard.
All of these.
The requirement that all drivers must carry auto insurance reduces
Question 22 options:
the effectiveness of signaling.
the chance of auto accidents.
Life insurance companies often give applicants a physical examination to prevent
Question 23 options:
the person from dying before obtaining the policy.
If bad drivers can usually avoid being ticketed by the police, then insurance companies will
Question 24 options:
use drivers’ driving record as a signal.
use drivers’ driving record as a screening device.
not be able to use drivers’ driving record as a screening device.
request driving records directly from the police and not from the individual applicant.
When a person has health insurance, they often have to pay nothing or very little (called a “copay”) to see a doctor. This might result in
Question 25 options:
their being overly healthy.
a principal-agent problem.
some moral hazard, since people might overuse the benefit.
an adverse selection problem.
In a store that sells souvenirs, suppose an agent receives a $1 commission for each unit sold, and the principal receives the residual profit. As a result
Question 26 options:
joint profit is maximized.
the agent will sell until the principal’s marginal cost equals $1.
no agent would enter into such a contract.
the agent wishes to sell as many units as he can.
Used car buyers will believe that a car is of good quality when the seller signals the car’s high quality by offering a warranty when
Question 27 options:
a warranty on a lemon is costly to the seller.
warranties are offered on all cars.
warranties are only offered on lemons.
a warranty on a good car is a false signal.
What role does a company like J.D. Power (which provides product satisfaction reviews) serve?
Question 28 options:
It provides a screening test.
It provides a signal of quality.
It reduces moral hazard.
It reduces costs of giving surveys.
eBay has a seller reputation system to provide
Question 29 options:
consumers with a signal concerning seller quality.
sellers a chance to signal other sellers concerning their quality.
a reduction in monopoly power.
improvements in investor relations.
The Department of Transportation certifies motorcycle helmets, and all helmets certified carry a “DOT” logo. This is an example of
Question 30 options:
signalling using established standards.
licensing to restrict entry by helmet manufacturers.
Restricting entry to a profession through licensing or certification requirements
Question 31 options:
may increase or decrease welfare.
leaves welfare unchanged.
Which of the following would be considered a contingent contract?
Question 32 options:
a piece rate contract
a profit-sharing contract
a contact with a bonus
All of these.
In the presence of asymmetric information, a piece-rate contract
Question 33 options:
is not as good as a contract based on commissions.
can lead to agents producing more output than would occur under a fixed-rent-paid-to-the-principal contract.
is impossible to write.
will result in the principal earning all of the profit.
In which type of contract is the agent paid per unit of output?
Question 34 options:
A commission based contract.
A sharecropping contract.
A piece rate contract.
A contract with stock options as salary.
Author A accepts a $5,000 advance from a publisher and a 10% royalty after 5,000 books are sold. Author B foregoes the publisher’s advance and negotiates for a 15% royalty on all books sold. Author C decides to self publish his book and keep 100% of all sales revenue. Which of these authors is most likely to have 10 books published?
Question 35 options:
They are all equally likely.
Many companies monitor their employees’ Internet use and email. Why might they be doing this?
Question 36 options:
Because they like to spy.
In order to improve morale.
To gain inside information on new consumer trends.
To reduce shirking.
If a firm has established monitoring devices that have a 50% chance of detecting shirking, and an employee gains $5,000 from shirking, the employer can deter shirking by having employees post a bond equal to
Question 37 options:
If a professional sports athlete signs a new contract which defers compensation until years after she is retired, she is signaling
Question 38 options:
that she does not plan to shirk in the future, regardless of whether she did so in the past.
that she did shirk and she will do so in the future.
that she did shirk but won’t do so in the future.
that she didn’t shirk and she won’t do so in the future.
An efficiency wage premium serves the same function as a bond because, just as with a bond, the premium represents
Question 39 options:
the amount the employee loses if caught shirking.
the expected value of the amount the employee loses if he shirks.
the cost of monitoring the employee.
the gain to the employee if he shirks.
A profit-maximizing firm that uses an efficiency wage and monitors will increase the wage it pays its workers until
Question 40 options:
the worker requires no monitoring.
the worker receives the market wage and requires full-time monitoring.
the cost of monitoring the worker equals the efficiency wage.
the change in the workers’ productivity from being monitored times the per time unit cost of monitoring equals one.