4) CARFAX is a company that compiles and sells histories of used cars. Used car dealers offer to
give their customers a copy of the CARFAX history of the cars in their inventory to
A) give buyers additional information about used cars for sale.
B) give sellers additional information about used cars for sale.
C) cause adverse selection.
D) so they need not offer warranties.
5) CARFAX is a company that compiles and sells histories of used cars. CARFAX reduces the
A) number of cars exchanged in the used car market.
B) information asymmetry in the used car market.
C) number of used cars offered for sale in the market.
D) cost of used cars in the market.
6) Quality information for goods that are sold online
A) is available from ratings given by other buyers.
B) is of no value because anyone can write anything on the Internet.
C) is unavailable because online sellers cannot be identified with certainty.
D) is ineffective at reducing asymmetric information problems.
7) The problems of thin markets can be addressed by
A) guaranteed price matching.
B) increasing the number of sellers in the market.
C) imposing price ceilings.
D) warranties and repair guarantees.
8) The problems of markets can be addressed by
A) guaranteed price matching.
B) increasing the number of sellers in the market.
C) imposing price ceilings.
D) money back guarantees.
9) By which of the following methods could a supplier identify its good as a plum to a skeptical
buyer?
A) money-back guarantee
B) warranties and repair guarantees
C) a verbal assurance
D) both A and B
10) In order to identify their used cars as plums (high-quality), many used car dealers
A) raise the minimum price of plums (high-quality).
B) advertise their prices.
C) offer money-back guarantees.
D) raise the minimum price of lemons (low-quality).
11) Lemon laws that allow consumers to return low-quality used cars are designed to help solve
the problem of ________ in used car markets.
A) moral hazard
B) thick markets
C) experience ratings
D) adverse selection
12) Which of the following is NOT an example of the efforts to reduce the adverse selection
problem?
A) Sellers offer warranties.
B) Consumers invest in information.
C) Sellers offer money-back guarantees.
D) All of the above are examples of efforts to reduce adverse selection.
13) A seller’s verbal assurances that a used car is a plum (high-quality car)
A) is not effective at reducing the problems associated with asymmetric information.
B) is an effective way for sellers to prove that the good they are selling is of high quality.
C) is a more efficient way to prove high quality than a money-back guarantee because it does not
cost the seller any money to make the assurance.
D) provides the same protection against adverse selection than does a repair guarantee.
14) A seller who is offering a low-quality used good for sale
A) is less likely to offer a money-back guarantee than is a seller who is selling a high-quality
good.
B) is more likely to offer a money-back guarantee than is a seller who is selling a high-quality
good.
C) is just as likely to offer a money-back guarantee than is a seller who is selling a high-quality
good.
D) is the only kind of seller who would ever offer a money-back guarantee because sellers of
high-quality goods do not have to offer guarantees.
15) Sellers of high-quality used goods are ________ likely to offer money-back guarantees
because ________.
A) more; buyers will not ask for their money back
B) less; buyers will be willing to purchase high-quality goods even without a guarantee
C) more; they are wealthier and so can afford to give money back
D) less; buyers consider guarantees to be a sign of an inferior good
Recall the Application about federal quality standards in the market for kiwifruit to
answer the following question(s).
16) Recall the Application. California kiwifruit growers had a asymmetric information problem
because potential buyers
A) do not know how much kiwifruit they will need.
B) could not tell what the price of the kiwifruit will be.
C) could not tell if a kiwifruit was sweet or sour before tasting it.
D) all of the above
17) Recall the Application. The federal government marketing order that helped reduce
asymmetric information about kiwifruit led to
A) a decrease in the spread between the price of New Zealand and U.S. kiwifruit.
B) lower quality kiwifruit sales.
C) more kiwifruit imports.
D) lower kiwifruit sales.
18) Recall the Application. The asymmetric information about kiwifruit was reduced by
A) reducing the price of U.S. kiwifruit.
B) advertising.
C) a federal government marketing order.
D) all of the above
19) Recall the Application. Prior to enactment of the federal government’s order,
A) grocers were willing to pay less for any California kiwifruit than for any New Zealand
kiwifruit.
B) grocers were willing to pay more for any California kiwifruit than for any New Zealand
kiwifruit.
C) grocers were willing to pay more for California kiwifruit that had been harvested at maturity
than for any New Zealand kiwifruit.
D) California and New Zealand kiwifruit sold for the same price.
20) Consumers can reduce their information disadvantage by investigating consumer satisfaction
surveys.
21) It is rational for someone who wants to sell a lemon to offer the buyer a money-back
guarantee.
22) Warranties reduce information asymmetry.
23) Repair guarantees are a sign the seller thinks they have a lemon.
Recall the Application about federal quality standards in the market for kiwifruit to
answer the following question(s).
24) Recall the Application. The U.S. kiwifruit information asymmetry was reduced by
advertising.
25) People who buy used homes often insist on having a “home inspection” before they finalize
the purchase. If the house fails the inspection the buyer has the right to refuse to buy the house
unless the seller fixes whatever problems are found. Does this help or hurt the seller?
26) For what kinds of goods are buyers most likely to seek additional information about quality?
27) Some states have laws that require that used car dealers give buyers a 30-day period during
which they can return cars that are discovered to be lemons (low-quality). Whom do laws like
this help? Whom do they hurt?
28) Who is more likely to offer a money-back guarantee: a seller of a lemon or a seller of a
plum? Why?
Recall the Application about federal quality standards in the market for kiwifruit to
answer the following question(s).
29) Recall the Application. Why were there so many “lemon” kiwifruit in the U.S. market?
9.3 Insurance and Moral Hazard
1) Which of the following is NOT an example of moral hazard?
A) People take poor care of their health because they have health insurance.
B) People drive recklessly because they have medical insurance.
C) People don’t lock their doors because they have theft insurance.
D) All of the above are examples of moral hazard.
2) Andy does not bother to lock the door to his house because he has theft insurance. This is an
example of
A) a positive spillover.
B) moral hazard.
C) adverse selection.
D) irrational behavior.
3) You do not worry about how your bank is investing your money because your deposits are
federally insured. This is an example of
A) a positive spillover.
B) moral hazard.
C) adverse selection.
D) irrational behavior.
4) Moral hazard is more likely to arise when
A) one side of an economic relationship cannot observe the behavior of those on the other side.
B) adverse selection is present.
C) insurance policies have high deductibles.
D) people are uninsured.
5) In communities where more people carry property insurance you would expect people to be
A) less careful about securing their possessions.
B) more careful about securing their possessions.
C) less likely to engage in behaviors that would be classified as moral hazard.
D) paying less for property insurance relative to communities where fewer people carry property
insurance.
6) Suppose that Harold buys collision insurance for his car and then drives it recklessly. This is
an example of
A) a positive spillover.
B) moral hazard.
C) adverse selection.
D) irrational behavior.
7) One way that insurance companies can reduce the moral hazard problem is to
A) make insurance customers pay a deductible before the company pays on a claim.
B) engage in genetic testing to determine who is more likely to be high risk.
C) eliminate copayments on insurance claims.
D) insure only customers with good morals.
8) Suppose that lenders believe that the government will provide assistance if too many of the
lenders’ borrowers do not pay back their loans. If lenders expect government assistance they will
A) make more loans to borrowers who are less likely to repay them.
B) make fewer loans to borrowers who are less likely to repay them.
C) increase the interest rates that they charge borrowers who are less likely to repay loans.
D) not change their lending policies because this expectation is not reasonable.
9) The existence of the Federal Deposit Insurance Corporation (FDIC)
A) increases the risk of moral hazard in the savings and loan industry.
B) reduces the risk of moral hazard in the savings and loan industry.
C) increases the risk that customers of savings and loans will engage in moral hazard, but
reduces the risk that the lenders will engage in moral hazard.
D) reduces the risk that customers of savings and loans will engage in moral hazard, but
increases the risk that the lenders will engage in moral hazard.
10) People who apply for loans know more about their ability to repay the loan than the lenders
do. This is an example of
A) asymmetric information.
B) public information.
C) a negative externality.
D) a community rating.
11) People who are the most willing to pay high interest rates for loans may have bad credit
ratings. This is an example of
A) moral hazard.
B) an experience rating.
C) adverse selection.
D) a negative spillover.
12) One result of asymmetric information about people’s ability to repay a loan is that
A) loans will only be made to people who don’t pay them back.
B) a bank could make many loans to people who don’t pay them back.
C) lenders are better off than with perfect information.
D) banks will not make loans.
Recall the Application about how having car insurance affects driving behavior to answer
the following question(s).
13) Recall the Application. The idea that an insured driver, who bears less than the full cost of a
collision, will drive less carefully than an uninsured driver is an example of
A) asymmetric information.
B) adverse selection.
C) moral hazard.
D) a thin market.
14) Recall the Application. A study of the effect of automobile insurance and traffic fatalities
conducted by Alma Cohen and Rajeev Dehejia estimates that a one percentage point decrease in
the number of uninsured drivers
A) decreases the number of traffic fatalities by 10%.
B) decreases the number of traffic fatalities by 0.5%.
C) has no measurable effect on the number of traffic fatalities.
D) increases the number of traffic fatalities by 2%.
15) The tendency for people who have good health insurance to take more risks with their health
is called adverse selection.
16) If John drives more recklessly because he has good automobile insurance it is an example of
moral hazard.
17) Insurance leads to taking less risk.
18) Adverse selection and moral hazard are two different terms that mean essentially the same
thing.
19) If Tom purchases a comprehensive auto insurance because he knows he is is a reckless
driver, his behavior is an example of moral hazard.
20) Copayments and deductibles in insurance policies increase moral hazard.
21) If Tom drives a car more recklessly after he purchases a comprehensive plan, the change in
his behavior is an adverse selection problem.
22) Deposit insurance creates a moral hazard that depositors have less incentive to monitor their
bank.
Recall the Application about how having car insurance affects driving behavior to answer
the following question(s).
23) Recall the Application. The theory of moral hazard suggests that uninsured drivers drive less
carefully than insured drivers.
24) Recall the Application. When a state makes car insurance compulsory, decreasing the
number of uninsured drivers, roads tend to become less hazardous.
25) What is moral hazard?
26) Health insurance leads to what types of moral hazards?
27) What are the main differences between adverse selection and moral hazard in the insurance
market?
28) Why can car insurance companies charge higher auto rates for new customers than for
established customers, all else held constant?
29) Suppose that everybody pays the same price for auto insurance. What should happen to the
price of insurance if the law changes from a system where there is mandatory auto insurance to
one where there is voluntary auto insurance?
Recall the Application about how having car insurance affects driving behavior to answer
the following question(s).
30) Recall the Application. Explain the effect of mandatory car insurance laws on the number of
traffic accidents and fatalities.
9.4 External Benefits and Public Goods
1) A market in which there are neither external benefits nor external costs is
A) efficient.
B) inefficient.
C) efficient and equitable.
D) impossible.
2) A public good is a good that
A) is consumed by a single person or household.
B) cannot be used by private citizens.
C) is available for everyone to consume, regardless of who pays.
D) is provided by the government.
3) A public good is a good that
A) is excludable.
B) is rival.
C) is free.
D) is available regardless of willingness to pay.
4) A private good is a good that
A) is consumed by a single person or household.
B) cannot be used by private citizens.
C) cannot result in external benefits or costs to those who don’t consume.
D) is available for everyone to consume, regardless of who pays.
5) If a good is available only to those who pay for it, the good is
A) excludable but not necessarily rival.
B) excludable and rival.
C) rival but not necessarily excludable.
D) nonrival and nonexcludable.
6) If a local government gives out water filters to low-income families free of charge, they are
A) public goods.
B) private goods.
C) external goods.
D) spillover goods.
7) A private good is a good that
A) is nonrival.
B) is not excludable.
C) is provided only by private sectors.
D) is consumed by a single person or household.
8) A good that is available for everyone to consume, regardless of who pays and who doesn’t, is
called a
A) private good.
B) external good.
C) public good.
D) spillover good.
9) A good that is available for everyone, regardless of who pays and who doesn’t, is
A) rival.
B) nonrival.
C) excludable.
D) nonexcludable.
10) A good that is consumed by a single person or household is
A) rival.
B) nonrival.
C) excludable.
D) nonexcludable.
11) An example of a public good is
A) national defense.
B) a hamburger.
C) a laundromat.
D) a personal computer.
12) An example of a private good is
A) national defense.
B) a bottle of perfume.
C) city streets and highways.
D) clean air.
13) If you see a movie at a theater, the movie is
A) a private good but nonrival in consumption.
B) a private good and rival in consumption.
C) a public good but nonexcludable.
D) a public good and nonrival.