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Frontiers of Microeconomics 5403
39. Employers can try to overcome the moral-hazard problem involving their employees by
a. paying their employees more often.
b. paying their employees below-equilibrium wages since the employees will likely shirk some of
their responsibilities.
c. better monitoring their employees' work efforts.
d. requiring their employees to take a pre-employment work effort test.
40. Peter was recently hired as a salesman for a national consulting firm. His job involves spending a
significant portion of his time out of the office visiting prospects and attending conferences. His
firm is paying him a wage that is higher than the equilibrium wage, but he receives much of his
income in quarterly bonuses based on how much he sells.
a. The consulting firm is trying to prevent adverse selection with its compensation strategy.
b. Peter has an incentive to go golfing with his buddies rather than conducting sales meetings.
c. The consulting firm is responding to the moral hazard problem with its compensation strategy.
d. Peter should quit this job and take a job where he gets paid an equilibrium wage more
frequently.
5404 Frontiers of Microeconomics
41. Peter was recently hired as a salesman for a national consulting firm. His job involves spending a
significant portion of his time out of the office visiting prospects and attending conferences. Which
of the following is a strategy the consulting firm may employ to discourage Peter from shirking his
responsibilities?
a. Tell Peter that the shareholders want to earn a large profit this year.
b. Pay Peter commissions on what he sells after the work has been completed.
c. Allow Peter to set his own schedule and work from home frequently.
d. Pay Peter a lower wage than he would earn in a similar job at another firm.
42. Peter was recently hired as a salesman for a national consulting firm. His job involves spending a
significant portion of his time out of the office visiting prospects and attending conferences. Which
of the following is a strategy the consulting firm may employ to discourage Peter from shirking his
responsibilities?
a. Tell Peter that the shareholders want to earn a large profit this year.
b. Stop paying Peter bonuses based on how much he’s sold.
c. Allow Peter to set his own schedule and work from home frequently.
d. Pay Peter an above-equilibrium wage.
Frontiers of Microeconomics 5405
43. Employers may choose to pay their workers a wage that exceeds the equilibrium wage according
to
a. efficiency-wage theories.
b. equilibrium wage theories.
c. screening theories.
d. signaling theories.
44. An efficiency wage
a. gives an employee an incentive to shirk his duties.
b. is lower than the equilibrium wage for that position and region.
c. is higher than the equilibrium wage for that position and region.
d. both a and b are correct.
45. A college professor hires a student to babysit her children and pays the student an efficiency-
wage. Which of the following is correct about the wage the student earns?
a. The wage is higher than the wage the student could earn working a similar job elsewhere.
b. The wage is the same as the wage the student could earn working a similar job elsewhere.
c. The wage is lower than the wage the student could earn working a similar job elsewhere.
d. The wage is likely to result in the student shirking responsibilities.
5406 Frontiers of Microeconomics
46. Which of the following is a plausible explanation for a firm paying above-equilibrium wages to its
workers?
a. It increases the probability that a worker who shirks will be caught.
b. It discourages workers from shirking out of fear of losing their high-paying job.
c. The Condorcet Paradox suggests that paying high wages will result in greater effort by
employees.
d. By paying a high wage, employers solve this adverse selection problem and motivate the
employees to work harder.
47. Susan buys automobile insurance from Provident Insurance Company. If Susan avoids having an
accident for three years, Provident will reduce the premiums she has to pay for her insurance.
Nevertheless, she routinely drives while eating or texting and speeds up to try to make it through
yellow lights.
a. This is an adverse selection problem which should be corrected with government intervention.
b. Susan is a principal and Provident is an agent in this principal-agent problem.
c. This is a moral hazard problem.
d. There is no way for Provident to determine whether Susan is a cautious or risky driver.
Frontiers of Microeconomics 5407
48. Steve borrowed some money from Summit Bank, telling the loan officer that he intended to use
the money to remodel his restaurant. After getting the loan, Steve and his girlfriend immediately
took the money and went gambling in Vegas.
a. This is an example of adverse selection since banks have difficulty selecting their customers.
b. This example does not involve asymmetric information.
c. From the given information, Steve is the principal and Summit Bank is the agent.
d. None of the above are correct.
49. When a night watchman only performs two walk-throughs per night when he is being paid to
perform five walk- throughs per night, it is an example of
a. both moral hazard and adverse selection.
b. neither moral hazard nor adverse selection.
c. moral hazard, but not adverse selection.
d. adverse selection, but not moral hazard.
5408 Frontiers of Microeconomics
50. 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.
51. 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. adverse selection.
b. moral hazard.
c. screening
d. signaling.
Frontiers of Microeconomics 5409
52. Kim owns a small business in Denver. She travels frequently, meeting with important customers,
and attending conferences. Kim hired Matt to work in the Denver office as the day-to-day
general manager of the business.
a. This is a moral hazard problem since Matt may not work as hard as Kim would like when he is
not monitored.
b. Kim choosing to hire Matt is an example of adverse selection since it is possible that Matt will
not work as hard as Kim expects.
c. Kim will most likely pay Matt a lower salary than normal since Kim will not be there to monitor
Matt’s work effort, and since Matt will not likely work hard knowing Kim cannot monitor his
effort.
d. Kim is the agent and Matt is the principal.
53. In corporations, a principal-agent problem can arise when
a. the shareholders are the principal and the managers are the agent.
b. the board of directors is the principal and the managers are the agent.
c. the shareholders are the principal and the board of directors is the agent.
d. All of the above are correct.
5410 Frontiers of Microeconomics
54. In corporations, which of the following are agents but not principals?
a. shareholders
b. the board of directors
c. managers
d. workers
55. In corporations, which of the following are principals but not agents?
a. shareholders
b. the board of directors
c. managers
d. workers
56. Adverse selection may lead to
a. owners of used cars choosing to keep them rather than sell them at the low price that skeptical
buyers are willing to pay.
b. wages being stuck above the level that balances supply and demand, resulting in unemployment.
c. buyers with low risk choosing to remain uninsured because the policies they are offered fail to
reflect their true characteristics.
d. All of the above are correct.
Frontiers of Microeconomics 5411
57. Adverse selection
a. occurs when the overall quality of choices facing a consumer is very low.
b. is a greater problem for employees than employers.
c. occurs more frequently in the market for new cars than used cars.
d. is not easily remedied by free markets.
58. Which of the following is not correct?
a. An example of adverse selection is man who tries to sell his used car without disclosing that it
needs a new transmission.
b. The “invisible hand” of a free market will always fix the problems of adverse selection and
moral hazard.
c. An employer may try to prevent a moral hazard problem by paying her workers an efficiency
wage.
d. One interpretation of gift giving is that it reflects asymmetric information and signaling.
5412 Frontiers of Microeconomics
59. 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 effect on the percentage of policy holders making claims, and (2) what is the effect on
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.
60. 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
Frontiers of Microeconomics 5413
61. Which of the following is a characteristic of a corporation but not of a small family-owned
business?
a. The corporation buys inputs in markets for the factors of production.
b. The corporation sells output in markets for goods and services.
c. The corporation is guided in its decisions by the objective of profit maximization.
d. The corporation faces a principal-agent problem created by the separation of ownership and
control.
62. 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.
5414 Frontiers of Microeconomics
63. 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.
64. 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
a. principal-agent problem.
b. moral-hazard problem.
c. adverse-selection problem.
d. signaling problem.
Frontiers of Microeconomics 5415
65. Which of the following is not an example of an adverse selection problem?
a. A homeowner purchases a refrigerator that the seller knows has a history of leaking.
b. A highly productive worker quits her job after a salary cut knowing that she can make more at
a different job.
c. A major league baseball player performs poorly in his second season after signing a multi-
million dollar contract.
d. A contractor uses low quality materials for construction but charges for higher quality
materials.
66. Bob 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.
5416 Frontiers of Microeconomics
67. The buyer runs a risk of being sold a good of low quality when there is
a. a principal-agent problem.
b. a moral-hazard problem.
c. a problem involving hidden actions.
d. a problem involving hidden characteristics.
68. Life insurance companies usually require applicants to have physicals and disclose information on
their health. This practice is designed to address
a. a principal-agent problem.
b. a moral-hazard problem.
c. a problem involving hidden characteristics.
d. all of the above are correct.
Frontiers of Microeconomics 5417
69. The state of Massachusetts requires all citizens to purchase medical insurance or face a monetary
penalty when filing their taxes. The penalty is significantly less than the average annual insurance
premium. Moreover, the state requires insurance companies to issue policies to anyone who
applies, regardless of their health at the time of application. Which of the following examples
describes the inherent adverse selection problem?
a. Tricia purchases an insurance policy through her employer and visits her doctor for annual
check-ups.
b. Sue purchases insurance only after learning that she has cancer.
c. Mike pays the penalty rather than purchasing insurance because it is cheaper for him than
paying insurance premiums and he is generally in good health.
d. Both b and c are correct.
70. When a jeweler sells a low quality diamond to a young man who believes the diamond is the
highest quality, she is engaging in
a. both moral hazard and adverse selection.
b. neither moral hazard nor adverse selection.
c. moral hazard, but not adverse selection.
d. adverse selection, but not moral hazard.
5418 Frontiers of Microeconomics
71. A street vendor sells a replica of a pair of designer shoes to a young woman who believes the
shoes are authentic. The street vendor is engaging in
a. both moral hazard and adverse selection.
b. neither moral hazard nor adverse selection.
c. moral hazard, but not adverse selection.
d. adverse selection, but not moral hazard.
72. Which of the following is an example of an adverse selection problem?
a. A customer purchases four apples, two of which are bruised.
b. A card shop puts its Halloween merchandise on sale on November 1st.
c. A young job applicant fails to reveal that she was fired from her last job because she was
incompetent.
d. A man rents a car and then drives it less carefully and fills it with cheaper gas than he would if
he owned it.
Frontiers of Microeconomics 5419
73. The Latin term caveat emptor, meaning "let the buyer beware," brings to mind the problem of
a. hidden actions.
b. adverse selection.
c. principals and agents.
d. moral hazard.
74. When the buyer knows less than the seller about the characteristics of the good being sold, there
is
a. a principal-agent problem.
b. a moral hazard problem.
c. an adverse selection problem.
d. a signaling problem.
75. The classic example of adverse selection is the
a. market for used cars.
b. market for new cars.
c. relationship between shareholders and managers.
d. relationship between a coach and an athlete.
5420 Frontiers of Microeconomics
76. The adverse selection problem is a likely explanation for the fact that
a. some parents use video cameras to monitor the nannies caring for their children.
b. some corporate managers were recently sent to prison for enriching themselves at the expense
of shareholders.
c. people in average health may be discouraged from buying health insurance by the high price.
d. gifts can be interpreted as signals.
77. People with hidden health problems are more likely to buy health insurance than are other people.
This is an example of
a. moral hazard and makes the cost of health insurance higher than otherwise.
b. moral hazard and makes the cost of health insurance lower than otherwise.
c. adverse selection and makes the cost of health insurance higher than otherwise.
d. adverse selection and makes the cost of health insurance lower than otherwise.
78. Severe adverse-selection problems may result in
a. too few good used cars being offered for sale.
b. wages that are too low relative to equilibrium levels.
c. too many good drivers buying too much automobile insurance.
d. people with average health buying too much health insurance.
Frontiers of Microeconomics 5421
79. "Signaling" refers to actions by an informed party for the sole purpose of
a. telling another party that the signaler has information to reveal, without actually revealing that
information.
b. conveying false information.
c. induce employees to put in the effort they are capable of.
d. credibly revealing private information.
80. Effective signals
a. convey useful information from informed parties to uninformed parties.
b. impose little or no cost on the signaler.
c. cannot be conveyed accurately when there is an information asymmetry.
d. raise the quantity sold but reduce the price sellers receive.
81. Which of the following is not an example of signaling?
a. screening
b. advertising
c. getting an education
d. gift giving
5422 Frontiers of Microeconomics
82. Which of the following is not an example of signaling?
a. An employer calls the references of a potential employee before hiring him or her.
b. A boyfriend gives his girlfriend a necklace with her favorite gemstone for Valentine’s Day.
c. A home flooring company advertises its high Better Business Bureau rating during its television
commercials.
d. A company advertises that it makes charitable contributions.
83. A woman gives her boyfriend a birthday present. The gift could be viewed by the boyfriend as a
a. moral hazard problem.
b. screening device.
c. signal of how much she cares for him.
d. All of the above are correct.
