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.
4. 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.
5. Which of the following relationships involves asymmetric information?
a.
A potential employee knows more about his skills and motivations than potential employers.
b.
The seller of a used car knows of mechanical problems that aren’t easy for the average buyer to observe.
c.
A real estate agent knows the lowest price a seller is willing to sell her house for, but does not reveal it to
people he shows the house.
d.
All of the above are correct.
6. Which of the following relationships involves asymmetric information?
a.
An employee is unsure what she will spend her annual performance bonus on.
b.
A loan applicant knows more about the likelihood her business will be successful than the loan officer.
c.
Someone considering buying running shoes looks at a number of online reviews by buyers.
d.
All of the above are correct.
7. 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.
8. Which of the following is an attempt to reduce the problem 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.
An insurance company requires people who want to purchase life insurance to take a physical exam.
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.
9. 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.
10. 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.
11. 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 condition.
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.
12. 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.
13. 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.
14. 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.
15. 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.
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.
18. 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.
19. 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.
20. 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
21. Which of the following is not an example of a principal trying to solve the moral-hazard problem? The principal
a.
calls the agent’s references.
b.
installs hidden cameras to monitor the agent’s behavior.
c.
pays the agent efficiency wages.
d.
pays the agent a year-end bonus.
22. Which of the following would be an example of a principal trying to deal with a moral hazard problem?
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.
23. 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.
24. 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.
25. 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 pays his employees year-end bonuses depending to how well the business does and his
observations of the employees’ efforts.
c.
The employer has voluntarily removed video cameras from the factory floor.
d.
Both A and B are correct.
26. Which of the following practices are, at least in part, attempts to reduce moral hazard problems?
a.
Parking ramps require customers to take a ticket with the time stamped on it from a machine in order to gain
entrance.
b.
Factory workers are paid by the hour.
c.
A restaurant owner works long hours in order to make more profit.
d.
None of the above are correct.
27. Which of the following practices are, at least in part, attempts to reduce moral hazard problems?
a.
The income of waiters and waitresses depends heavily on tips.
b.
An employer pays below equilibrium wages because he thinks his employees are not working as hard as they
could be.
c.
The professors leaves the room to prevent cheating on exams.
d.
Tenure professors are not supervised closely.
28. 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.
29. Which of the following is an example of moral hazard?
a.
a driver is arrested for drunk driving
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.
30. 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
a.
adverse selection.
b.
a Condorcet paradox.
c.
a screening problem.
d.
a moral hazard problem.
31. 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
32. Rick goes to work 8 hours per day, but while he is at work he spends most of his time visiting internet sites monitoring
his fantasy football teams. This is an example of
a.
the Condorcet Paradox.
b.
signaling.
c.
moral hazard.
d.
screening.
33. In the case of a moral-hazard problem, which of the following is not a way for the principal to encourage the agent to
act more responsibly? The principal could
a.
better monitor the agent.
b.
pay the agent above-equilibrium wages.
c.
delay payment to the agent.
d.
stop paying bonuses.
34. Studies show that during the March Madness college basketball tournament, the productivity of the average company
in the US falls considerably. This is an example of
a.
the Condorcet Paradox.
b.
signaling.
c.
moral hazard.
d.
screening.
35. Which of the following is not a common response to the moral hazard problem that employers face?
a.
offering all employees some funding for additional education
b.
paying efficiency wages
c.
requiring employees to provide itemized receipts for reimbursable expenses
d.
paying year-end bonuses rather than higher monthly earnings
36. You own an ice cream store and are concerned that an employee may be giving generous scoops to friends and
relatives and smaller scoops to some other customers. This is an example of
a.
a moral hazard problem.
b.
adverse selection.
c.
behavioral economics.
d.
signaling.
37. You own an ice cream store and are concerned that an employee may be giving generous scoops to friends and
relatives and smaller scoops to some other customers. This may be reducing sales. In this example, you are the
a.
principal and the your employee is the agent.
b.
agent and the your employee is the principal.
c.
signaler and the your employee is the screener.
d.
screener and the owner of the coffee ship is the signaler.
38. You own an ice cream store and are concerned that an employee may be giving generous scoops to friends and
relatives and smaller scoops to some other customers. This may be reducing sales. If you want your employee to stop
giving larger scoops to friends and relatives, which of the following is not a good approach?
a.
Make visits to the store at the same time each day.
b.
Pay employees an above equilibrium wage.
c.
Give your employees a monthly bonus based on profits.
d.
None of the above are good approaches.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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
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.
63. The fact that someone with information about a significant number of illnesses in their family history is likely to
purchase health insurance is an example of
a.
adverse selection.
b.
monitoring.