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Chapter 22 Frontiers in Microeconomics
MULTIPLE CHOICE
1. Which of the following is not correct?
a.
Economics is a study of the choices that people make and the resulting interactions they
have with one another.
b.
Economists are not interested in finding new areas to study and new phenomena to
explain.
c.
Economists are trying to expand their understanding of human behavior and society.
d.
The economics of asymmetric information, political economy, and behavioral economics
are all topics at the frontier of microeconomics.
2. Asymmetric information, political economy, and behavioral economics
a.
are topics at the frontier of microeconomics.
b.
are topics that economists no longer research.
c.
are being studied as economists try to expand their understanding of human behavior and
society.
d.
both a and c are correct.
3. When one party is better informed about an economic situation than another party, economists de-
scribe the problem as one of
a.
asymmetric information.
b.
moral hazard.
c.
political economy.
d.
behavioral economics
4. When markets fail, which of the following is true?
a.
Government intervention can always improve outcomes.
b.
Government intervention can potentially improve outcomes.
c.
Government intervention can never improve outcomes.
d.
Markets do not fail.
2 ❖ Chapter 22/Frontiers in Microeconomics
5. The field of behavioral economics builds a more subtle and complex model of economic behavior
using insights from
a.
physics.
b.
biology.
c.
psychology.
d.
anthropology.
6. Which of the following frontier areas of economics incorporates some findings from psychology
into the study of economic issues?
a.
Asymmetric information
b.
Political economy
c.
Behavioral economics
d.
Public economics
ASYMMETRIC INFORMATION
1. In economics, a difference in access to relevant knowledge is called a(n)
a.
relevancy frontier.
b.
knowledge gap.
c.
information asymmetry.
d.
information equilibrium.
2. Informational asymmetry is a difference in
a.
efficiency.
b.
equality.
c.
relevant knowledge.
d.
signaling.
3. Information asymmetry refers to
a.
the tendency of a person who is imperfectly monitored to engage in dishonest or otherwise
undesirable behavior.
b.
the tendency for the mix of unobserved attributes to become undesirable from the
standpoint of an uninformed party.
c.
an action taken by an informed party to reveal private information to an uninformed party.
d.
a difference in access to relevant knowledge.
Chapter 22/Frontiers in Microeconomics ❖ 3
4. The 2001 Nobel prize in economics was awarded to George Akerlof, Michael Spence, and Joseph
Stiglitz for their work on
a.
asymmetric information.
b.
political economy.
c.
behavioral economics.
d.
growth theory.
5. Which of the following relationships involves asymmetric information?
a.
An employee knows more than his employer knows about his work effort.
b.
A borrower knows more than the lender about his ability to repay the loan.
c.
The seller of a 30-year-old house knows more than the buyer about the condition of the
house.
d.
All of the above are correct.
6. Which of the following relationships involves asymmetric information?
a.
Patients can look up information regarding certain prescription drugs giving them the
same information as their doctors.
b.
Consumer Reports allows customers of DVD players to know as much about the quality of
various players as the store salesperson.
c.
Car Fax allows car buyers to obtain used-vehicle histories providing them with the same
information as the dealership salesperson.
d.
The batter in a baseball game must guess whether the pitcher is going to throw a fastball,
curveball, or change-up.
7. Which of the following is an example of asymmetric information?
a.
When someone is applying for a job, the employer checks references to determine the
previous work habits of the applicant.
b.
When an employee purchases group life insurance without taking a physical exam, she
knows more about her health than does the insurance company.
c.
When someone is considering buying a used car from a dealership, the potential buyer
requests documentation of the repair history of the car.
d.
All of the above are correct.
4 ❖ Chapter 22/Frontiers in Microeconomics
8. Which of the following is not an example of asymmetric information?
a.
When someone is applying for a job, the employer checks references to determine the
previous work habits of the applicant.
b.
When an employee purchases group life insurance without taking a physical exam, she
knows more about her health than does the insurance company.
c.
When someone is considering buying a used car from a dealership, the dealer knows more
about the true condition of the car than does the potential buyer.
d.
All of the above are examples of asymmetric information.
9. A driver knows more than his auto insurer about how cautiously he drives. This is an example of
a.
a hidden action.
b.
a hidden characteristic.
c.
adverse selection.
d.
the Condorcet Paradox.
10. Frequently it is the case that: (1) A worker knows more than his employer about how much effort he
puts into his job, and (2) the seller of a used car knows more than the buyer about the car's condi-
tion.
a.
Neither (1) nor (2) serves as an example of asymmetric information.
b.
Both (1) and (2) serve as examples of asymmetric information.
c.
Neither (1) nor (2) serves as an example of a hidden action.
d.
Both (1) and (2) serve as examples of hidden action.
11. Asymmetric information
a.
is not an area of current research in economics.
b.
can take the form of a hidden action or a hidden characteristic.
c.
explains Arrow’s impossibility theorem.
d.
is uncommon in corporate management.
12. Government action in cases of asymmetric information may not be an ideal solution because
a.
the private market can sometimes deal with information asymmetries on its own.
b.
the government tends to have more information than private parties.
c.
both (a) and (b).
d.
None of the above is correct.
Chapter 22/Frontiers in Microeconomics ❖ 5
13. 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 rarely has more information than the private parties.
b.
Private markets can sometimes deal with information asymmetries on their own.
c.
The government is itself an imperfect institution.
d.
All of the above are valid concerns.
14. Which of the following is an example of informational asymmetry?
a.
A seller of a house knows more about its true condition than does a potential buyer.
b.
A salesperson knows more about her efforts than does her manager.
c.
A child knows more about how much time he spent playing video games while he was
alone in his bedroom than do his parents.
d.
All of the above are correct.
15. When asymmetric information affects a relationship between two parties, it is always the case that
a.
neither party is well informed.
b.
one party is better informed than the other party.
c.
both parties are equally well informed.
d.
the government is better informed than either of the two parties.
16. Which of the following statements is correct?
a.
Hidden actions and hidden characteristics are both associated with the moral-hazard
problem.
b.
Hidden actions and hidden characteristics are both associated with the adverse-selection
problem.
c.
Hidden actions are associated with the moral-hazard problem, whereas hidden
characteristics are associated with the adverse-selection problem.
d.
Hidden actions are associated with the adverse-selection problem, whereas hidden
characteristics are associated with the moral-hazard problem.
17. The problem that arises when one person performs a task on behalf of another person is called
a.
the hidden characteristics problem.
b.
the lemons problem.
c.
moral hazard.
d.
adverse selection.
6 ❖ Chapter 22/Frontiers in Microeconomics
18. Which of the following is not an example of a principal-agent relationship?
a.
a soccer player and her coach
b.
a man and his neighbor
c.
an construction worker and his foreman
d.
a driver and her insurance agent
19. Which of the following is not an example of a principal trying to solve the moral-hazard problem?
a.
the principal conducts an extensive interview of the agent
b.
the principal installs hidden cameras to monitor the agent’s behavior
c.
the principal pays the agent efficiency wages
d.
the principal pays the agent a year-end bonus
20. Which of the following would be an example of a principal trying to deal with a moral hazard prob-
lem?
a.
The parents of an infant secretly place video cameras in their house before the baby-sitter
arrives.
b.
An insurance company checks police records to determine if its policyholders have
received traffic citations.
c.
An employer examines his workers' output on a daily basis.
d.
All of the above are correct.
21. When a corporation decides to include its own corporate stock as part of the compensation for its
employees, it is trying to solve the
a.
adverse selection problem.
b.
principal-agent problem.
c.
lemons problem.
d.
signaling problem.
Chapter 22/Frontiers in Microeconomics ❖ 7
22. Which of the following offers an explanation as to why the principal-agent problem exists for a
firm?
a.
The firm cares less about profit and more about cost when there are many competitors in
the market.
b.
The firm offers an employee-incentive program in which employees share in the firm’s
profits.
c.
The firm operates in a market with many competitors forcing the firm to pay its employees
more to keep them from switching to another firm.
d.
The firm operates to maximize profit while the employees attempt to work as little as
possible to earn their paychecks.
23. Which of the following practices would indicate that an employer is trying to overcome a moral-
hazard problem with his employees?
a.
The employer pays his workers wages that are unusually high for the industry and region.
b.
The employer has voluntarily removed video cameras from the factory floor.
c.
The employer has discontinued the practice of giving his employees' year-end bonuses.
d.
Both A and B are correct.
24. Which of the following is not an example of moral hazard?
a.
a person with car insurance drives recklessly
b.
a pet-sitter being paid to walk a dog for one hour per day only walks the dog for 20
minutes per day
c.
a thief steals a car
d.
All of the above are examples of moral hazard.
25. In the case of a moral-hazard problem, which of the following is not a way for the principal to en-
courage the agent to act more responsibly?
a.
the principal could better monitor the agent
b.
the principal could pay the agent above-equilibrium wages
c.
the principal could delay payment to the agent
d.
the principal could pay the agent below-equilibrium wages
26. Which of the following is not a common response to the moral hazard problem that employers face?
a.
providing an on-site workout facility
b.
paying efficiency wages
c.
requiring employees to provide itemized receipts for reimbursable expenses
d.
paying year-end bonuses rather than higher monthly earnings
8 ❖ Chapter 22/Frontiers in Microeconomics
27. Which of the following is not an example of a moral hazard problem?
a.
A manager stays late one evening so that her employee can leave early to attend his child’s
music recital.
b.
A small child takes an extra cookie from the cookie jar when he thinks his mom isn’t
watching him closely.
c.
An employee plays solitaire on her computer at 4:30 p.m. on a Friday when her boss has
left for the day.
d.
A customer whose new eyeglasses come with a “60-day insurance policy in case of
breakage” leaves her glasses out where her new puppy can chew on them.
28. 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 her employer.
29. Your friend works at a coffee shop on campus and regularly gives away free coffee to you and your
friends when you visit. This is an example of
a.
a moral hazard problem.
b.
adverse selection.
c.
behavioral economics.
d.
signaling.
30. Your friend works at a coffee shop on campus and regularly gives away free coffee to you and your
friends when you visit. In this example, your friend is the
a.
principal and the owner of the coffee shop is the agent.
b.
agent and the owner of the coffee shop is the principal.
c.
signaler and the owner of the coffee shop is the screener.
d.
screener and the owner of the coffee ship is the signaler.
Chapter 22/Frontiers in Microeconomics ❖ 9
31. Your friend works at a coffee shop on campus and regularly gives away free coffee to you and your
friends when you visit. If the owner of the coffee shop wants to stop your friend from giving away
coffee, which of the following is not a good approach?
a.
Set up a video camera to monitor the shop when the owner is not present.
b.
Pay your friend a wage higher than he could earn elsewhere for the same position.
c.
Pay your friend in advance based on projected revenue each month.
d.
Pay your friend part of his compensation as a monthly bonus based on revenue.
32. The temptation of imperfectly-monitored workers to shirk their responsibilities is
a.
an example of the moral hazard problem.
b.
an example of the adverse selection problem.
c.
an example of screening.
d.
an example of signaling.
33. 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.
34. 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 in-
come 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.
35. 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
10 ❖ Chapter 22/Frontiers in Microeconomics
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.
36. 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.
37. 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.
38. 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.
39. 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.
Chapter 22/Frontiers in Microeconomics ❖ 11
40. Manuel buys automobile insurance from Ax-i-Dent Insurance Company. If Manuel avoids having an
accident for three years, Ax-i-Dent will reduce the price he has to pay for his insurance. Neverthe-
less, he routinely drives fast and with reckless abandon.
a.
This is an adverse selection problem which should be corrected with government
intervention.
b.
Manuel is a principal and Ax-i-Dent is an agent in this principal-agent problem.
c.
This is a moral hazard problem.
d.
There is no way for Ax-i-Dent to determine whether Manuel is a cautious or risky driver.
41. Kevin borrowed some money from Hi Interest Bank, telling the loan officer that he intended to use
the money to make repairs to his home. After getting the loan, Kevin and his girlfriend immediately
took the money and headed to the nearest riverboat casino for a weekend of gambling and entertain-
ment.
a.
This is an example of adverse selection since banks have difficulty selecting their
customers.
b.
This is a typical example of the Condorcet Paradox.
c.
From the given information, Kevin is the principal and his girlfriend is the agent.
d.
From the given information, Hi Interest Bank is the principal and Kevin is the agent.
42. When a night watchman only performs two walk-throughs per night when he is being paid to per-
form 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.
43. 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
12 ❖ Chapter 22/Frontiers in Microeconomics
initially surprising because Volvo has built a reputation as an especially safe car that appeals to sen-
sible, 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.
44. 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 insur-
ance 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.
45. 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 gen-
eral manager of the business.
a.
This is a moral hazard problem since Nicole may not work as hard as Bill would like when
she is not monitored.
b.
Bill choosing to hire Nicole is an example of adverse selection since it is possible that
Nicole will not work as hard as Bill expects.
c.
Bill will most likely pay Nicole a lower salary than normal since Bill will not be there to
monitor Nicole’s work effort, and since Nicole will not likely work hard knowing Bill
cannot monitor her effort.
d.
The Condorcet Paradox implies that Nicole will not work as hard as Bill would like even
though he will likely pay her an above equilibrium wage.
Chapter 22/Frontiers in Microeconomics ❖ 13
46. When new professors are hired, their job performance is monitored closely. If they meet their insti-
tution's standards, they will eventually receive tenure. After receiving tenure, professors' job perfor-
mance 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.
a moral hazard problem.
47. Pedro, who knows nothing about construction, paid Benito to remodel a room in his house. Two
years later, one wall in the remodeled room crumbled because Benito used poor-quality materials.
This illustrates which economic problem?
a.
adverse selection
b.
screening
c.
moral hazard
d.
signaling
48. Rick goes to work 8 hours per day, but while he is at work he spends most of his time visiting inter-
net sites monitoring his fantasy football teams. This is an example of
a.
the Condorcet Paradox.
b.
signaling.
c.
moral hazard.
d.
screening.
49. Studies show that during the March Madness college basketball tournament, the productivity of av-
erage company in the US falls considerably. This is an example of
a.
the Condorcet Paradox.
b.
signaling.
c.
moral hazard.
d.
screening.
50. 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.
14 ❖ Chapter 22/Frontiers in Microeconomics
51. In corporations, which of the following are agents but not principals?
a.
shareholders
b.
the board of directors
c.
managers
d.
workers
52. In corporations, which of the following are principals but not agents?
a.
shareholders
b.
the board of directors
c.
managers
d.
workers
53. Insurance companies charge annual premiums to collect revenue, which they then use to pay cus-
tomers 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 aver-
age 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.
54. Insurance companies charge annual premiums to collect revenue, which they then use to pay cus-
tomers 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: cus-
tomers that file a lot of claims. After creating these groups, what happens to the average annual pre-
mium 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
Chapter 22/Frontiers in Microeconomics ❖ 15
55. Which of the following is a characteristic of a corporation but not of a small family-owned business?
a.
The firm buys inputs in markets for the factors of production.
b.
The firm sells output in markets for goods and services.
c.
The firm is guided in its decisions by the objective of profit maximization.
d.
The firm faces a principal-agent problem created by the separation of ownership and
control.
56. 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.
57. 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.
58. 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.
16 ❖ Chapter 22/Frontiers in Microeconomics
59. 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 prob-
lem. This is an example of
a.
moral hazard.
b.
screening.
c.
adverse selection.
d.
the principal-agent problem.
60. 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.
61. 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.
62. 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.
63. 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.
Chapter 22/Frontiers in Microeconomics ❖ 17
64. 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.
65. 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.
66. A street vendor sells a replica of a designer handbag to a young woman who believes the handbag is
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.
67. 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 worker is fired after she is late for work three times in one month.
d.
A man whose father had a heart attack wants to increase his life insurance coverage.
68. 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.
18 ❖ Chapter 22/Frontiers in Microeconomics
69. 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.
70. 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.
71. 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.
72. 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.
73. Because people with hidden health problems are more likely to buy health insurance than are other
people,
a.
the price of health insurance reflects the costs of a sicker-than-average person.
b.
the price of health insurance is too low, relative to the socially-optimal price.
c.
people in average health may be encouraged to buy too much health insurance, relative to
the socially-optimal quantity.
d.
the Condorcet Paradox suggests that people who are sicker than average will ultimately
buy more health insurance.
Chapter 22/Frontiers in Microeconomics ❖ 19
74. 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.
75. "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.
confusing another party.
d.
credibly revealing private information.
76. 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.
can be used by employers to alleviate the moral hazard problem in the workplace.
77. Which of the following is not an example of signaling?
a.
screening
b.
advertising
c.
getting an education
d.
gift giving
78. Which of the following is not an example of signaling?
a.
An employer asks if he can run a background check on 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.
An college applicant lists her membership in academic honor societies on her application.
20 ❖ Chapter 22/Frontiers in Microeconomics
79. 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.
80. A brand of wine is priced at only $5 per bottle, far below the market price of most high quality
wines. Before any reputation exists for the wine, consumers buy very little of this inexpensive wine
because they interpret the low price to mean that the wine is of poor quality. The company decides
to change the label on the wine to show that it has won awards for quality. This label change is an
example of
a.
signaling.
b.
screening.
c.
selecting.
d.
All of the above are correct.
81. If the seller of a used car offers a limited warranty, the warranty is an example of a(n)
a.
signal.
b.
screen.
c.
efficiency wage.
d.
agent.
82. A home has been on the market for an extended amount of time without much interest from buyers.
The sellers decide to purchase and include a home warranty insuring against major defects with the
home. The warranty is an example of a(n)
a.
signal.
b.
screen.
c.
moral hazard.
d.
adverse selection.
83. A firm with a very good product
a.
has a higher cost of signaling (advertising) than does a firm with an inferior product.
b.
has more to gain by signaling (advertising) than does a firm with an inferior product.
c.
does not need to signal (advertise) because the product’s quality speaks for itself.
d.
will signal (advertise) effectively if signaling is free.
