CHAPTER 11

Jack is considering selling his elliptical machine, which he never really used, is high quality, and has been taking up space in his spare bedroom. He lists it on Facebook Marketplace for "$1,200 or best offer" but in reality won't sell it for less than $1,000 . Lina is looking to purchase a used elliptical machine. For a high‑quality elliptical, she is willing to pay up to $1,300, and for a low‑quality elliptical, she is willing to pay $600. Lina is risk neutral but she cannot tell if the elliptical machine is high quality or low quality. a. If she believes that 60% of used elliptical machines are high quality and 40% are low quality, what is the maximum price that Lina would be willing to pay? Lina's maximum price: $ Would Jack agree to this price? since it is (higher/ lower) than his lowest acceptable price, he (would/ would not)

1020; higher; would

What is the difference between asymmetric information, adverse selection, and moral hazard? Check all that apply -Adverse selection and moral hazard are both types of asymmetric information problems. -Adverse selection is about hidden characteristics, usually before a transaction has taken place. -Asymmetric information is a synonym for adverse selection, but moral hazard is a type of principal-agent problem. -Moral hazard is about hidden actions when people don't bear the full cost of their actions.

Adverse selection and moral hazard are both types of asymmetric information problems; Adverse selection is about hidden characteristics, usually before a transaction has taken place; Moral hazard is about hidden actions when people don't bear the full cost of their actions.

What worsens adverse selection in a dental insurance market where buyers have private information? -Grouping buyers by a risk factor and charging a premium based on risk. -Selling only to risk-averse buyers. -Requiring that each buyer's premium be based on that specific buyer's costs. -Allowing buyers to opt-in and opt-out of the market at any time they desire.

Allowing buyers to opt-in and opt-out of the market at any time they desire.

The adverse selection of sellers is the -tendency for buyers to choose to buy from sellers who are not trustworthy even when product quality is high. -tendency for the mix of goods to be skewed toward more low-quality goods when buyers can't observe quality. -skew in markets toward buyers who pay less when sellers cannot tell a buyer's willingness to pay. -skew in markets when sellers cannot observe quality that leads to lower prices.

tendency for the mix of goods to be skewed toward more low-quality goods when buyers can't observe quality.

If a doctor knows that an insurance company will pay for most of a patient's bill, the doctor has more of an incentive to require additional medical procedures and tests, even if the patient may not require them. This is an example of -the principle-agent problem -none of these. -adverse selection.

the principle-agent problem

Which statement is the best definition of the term adverse selection? -when competitive forces drive inefficient firms out of the market and leave only efficient firms in existence -when complete information is available to all parties involved in the purchase of a product -when either a buyer or seller knows more about a product's quality than does the other party and this extra knowledge has no effect on either party -when more information is available to one side of the market (i.e., buyer or seller), resulting in the less knowledgeable party incurring costs as a result of this information deficiency -when people engage in riskier behavior than they would otherwise because insurance prevents them from facing the true costs of their actions

when more information is available to one side of the market (i.e., buyer or seller), resulting in the less knowledgeable party incurring costs as a result of this information deficiency

Which statement is not an example of adverse selection? -Individuals who expect more health problems are more likely to buy generous health insurance policies. -A person does not buy a car alarm because auto theft is covered in her insurance policy. -Relative to all cars with similar observable characteristics, those in the used car market are less reliable.

A person does not buy a car alarm because auto theft is covered in her insurance policy.

Suppose that Belinda challenges Sara to a wager over a coin toss. If the coin lands heads up, Sara loses and has to pay Belinda $25. If the coin lands heads down (tails up), Sara wins and Belinda pays her $60. What is Sara's expected value of accepting the wager? Is it economically rational for Sara to agree to the wager, and why? -No, agreeing to any wager is economically irrational by definition. -Yes, the expected value of the wager is positive. -Yes, the expected value of the wager is negative. -No, the expected value of the wager is negative.

$17.50; Yes, the expected value of the wager is positive.

Sophia operates her own accounting practice and is looking to hire two entry‑level accountants. A high‑productivity worker will generate $90,000 in revenue per year and a low‑productivity worker will generate $60,000. Tasia is a high‑productivity worker and wants a salary of at least $80,000. Rick is a low‑productivity worker and wants at least a $55,000 salary. It's more likely that Sophia can't tell who will be a high‑ or low-productivity worker from an interview. But based on her experience, she believes that 65% of workers are low productivity and 35% of workers are high productivity. Find the maximum salary that she would be willing to pay and determine who will accept her job offer. Does this change the maximum she is willing to pay for an accountant of unknown quality? The maximum salary that she would be willing to pay is ____ In this case, (who) will accept her offer at that salary. Sophia will offer more only if (she finds a way to distinguish low- and high-productivity workers/ she cannot fill both positions)

$70500; only rick; she finds a way to distinguish low- and high-productivity workers

Consider a simple example of moral hazard. Suppose that Lucas goes into a casino to make one bet a day. The casino is very basic; it has two bets: a safe bet and a risky bet. In the safe bet, a nickel is flipped. If the nickel lands on heads, Lucas wins $100 If it lands on tails, Lucas loses $100 The risky bet is similar: a silver dollar is flipped. If the silver dollar lands on heads, Lucas wins $5,000 If it lands on tails, Lucas loses $10,000. Each coin has a 50% chance of landing on each side. What is the expected value of the safe bet? safe bet: $ What is the expected value of the risky bet? risky bet: $ Now suppose that an insurance company opens outside of the casino. They notice that Lucas, like everyone else, always leaves the casino having played the safe bet, so they offer to sell Lucas insurance for $50 that, if he loses, covers his losses. If Lucas wins, he does not have to pay anything extra, having already paid the $50. Note that as long as Lucas does not change his behavior, the insurance company makes $0 in expectation. Once Lucas buys the insurance, what are his expected winnings from the safe bet? Ignore the cost of the insurance. safe bet: $ Once Lucas buys the insurance, what are his expected winnings from the risky bet? Ignore the cost of insurance. risky bet: $ If the insurance company sells insurance to Lucas, should you expect to find that it loses money? Why? -Yes; since Lucas no longer pays for his losses, he gets a higher expected payoff from the risky bet. -No; the safe bet has the higher expected value before insurance, so Lucas still chooses that one. -Maybe; the bets now have an equal expected value, so Lucas might pick either one.

0; -2500; 50; 2500; Yes; since Lucas no longer pays for his losses, he gets a higher expected payoff from the risky bet.

Which of the following is NOT an example of a solution to an adverse selection problem caused by the seller's having private information? -A list of award winners and top-tier producers is published by the organization of experts that judges an annual chocolate bar quality competition. -A company makes sure that all its employees enter positive product reviews on an online website that reports product reviews. -A hairstylist offers a free brief follow-up appointment within a week of a haircut to adjust anything the customer does not like about a cut. -A government requires miles-per-gallon labeling on all automobiles sold in the country.

A company makes sure that all its employees enter positive product reviews on an online website that reports product reviews

Which is NOT an example of moral hazard? -A hairdresser colors a client's hair poorly. -A cab driver takes a longer route to the destination to collect a higher fare. -A dentist recommends an unnecessary dental procedure. -A car salesman recommends a car that has been wrecked.

A hairdresser colors a client's hair poorly.

Who is least likely to buy health insurance when individuals have private information about their health and health insurance is optional? -A young adult in good health -A person who has a family history of cancer -An obese person -A person who is 60 years old and in good health

A young adult in good health

Using new technology, some insurers are offering customized rates for buyers who install equipment in their car that monitors speed, acceleration, distance traveled, and other factors. What problems are the insurance companies trying to solve? -Moral hazard, since people who drive badly will not purchase this type of insurance. -Both adverse selection and moral hazard, since only those who know they drive safely will purchase this insurance, and they are less likely to drive dangerously since they know they are being monitored. -Neither adverse selection nor moral hazard. Insurance companies are simply trying to price discriminate. -Adverse selection, since good drivers know they do not need this type of insurance and will shop elsewhere.

Both adverse selection and moral hazard, since only those who know they drive safely will purchase this insurance, and they are less likely to drive dangerously since they know they are being monitored.

Which of the following worsens adverse selection due to buyers having private information? -Sellers have very limited ability to change price. -Buyers have constraints on their ability to buy or not buy whenever they want to. -Sellers have flexibility to lower price but not to raise price. -Buyers have the choice to buy or not buy whenever they want to.

Buyers have the choice to buy or not buy whenever they want to.

Which one of the following is NOT an example of a seller offering signals of quality? -Chau asks customers to write reviews of her manicures on a website for local businesses. -Ian's Auto Body Shop offers a warranty on its work. -Mak offers a money-back guarantee on his product. -Hui Er proofreads her job application and cover letter four times to make sure it shows that she is careful about details.

Chau asks customers to write reviews of her manicures on a website for local businesses.

In the United States, the bulk of health care spending is paid by health insurance companies or the government through Medicare and Medicaid. Such a system is also called a third-party payer system where consumers of health care pay a nominal fee and the rest are paid by the health insurance provider. Why might such a system lead to an inefficient outcome? -Physicians concerned that insurance companies may not approve payments tend not to order expensive tests for their patients. -Consumers have an incentive to over-consume health care services because they pay prices well below the cost of providing these services. -Health insurance companies do not have an incentive to control cost and therefore increase demand for cutting edge medical treatments. -Consumers fearing that excessive use of health care services may lead to a rise in insurance premiums tend to under-consume health care services.

Consumers have an incentive to over-consume health care services because they pay prices well below the cost of providing these services.

The signaling model in education suggests that earning a degree -None of these. -Is irrelevant as long as you know the material. -Is what actually makes you more productive, not the content of your coursework. -Is crucial because it is the costly signal that indicates you are a high-quality worker, even if you did not learn anything of value.

Is crucial because it is the costly signal that indicates you are a high-quality worker, even if you did not learn anything of value.

Which of the following is an example of a principal-agent problem? -Jordan buys a new car that seems to have more flaws than the average new car. -Ingrid is highly risk-averse and tends to over-insure against loss. -Jeff, a CEO, puts pressure on his staff to increase productivity. -Maria slacks off at work when her boss is on vacation.

Maria slacks off at work when her boss is on vacation.

Unlike perfectly competitive markets, health insurance and health care markets are characterized by asymmetric information in many forms. To see the consequences, consider the following scenario: The population is evenly divided between 2 types of people: healthy people and unhealthy people. Healthy people have expected health care costs of $1000 per year. Unhealthy people have expected health care costs of $5000 per year. Unhealthy people can become healthy by working out, eating healthier, and taking preventive care. Assume that the cost of becoming healthy in terms of time and effort is $2000 per year. These people live in a city with one employer who will hire anyone who is willing to work. This employer provides complete health care to all its employees; all health care costs are covered by the insurance. Do the unhealthy employees have an incentive to become healthy? -No -There is not enough information to tell. -Yes What is the expected cost of insurance for all the workers? Expected cost: $ Suppose a new employer that pays $1500 more in wages per worker but does not offer any insurance (and there is no market for health insurance) enters the market. Which people will go and work for the new employer? -Both groups -None -The healthy -The unhealthy What would the new expected cost of insurance be at the original firm? New expected cost: $

No; $3000; healthy; $5000

Which of the following is an example of a principal-agent problem? -Buyers opt to buy the low-cost, low-quality version of a product even though they say their primary goal is high quality. -Workers are motivated to do their best on the job regardless of compensation. -A firm fails to earn profits because a manager mismanages the employees. -Shareholders hire a CEO to increase profits, and the CEO remodels the office with expensive artwork and furnishings.

Shareholders hire a CEO to increase profits, and the CEO remodels the office with expensive artwork and furnishings.

You buy a brand-new car and take good care of it. But after two months and just a thousand miles of driving, you decide you need something bigger and decide to sell your car. Compared to what you paid for it, what price should you expect to receive and why? -About what you paid for it, since it is barely used and buyers can verify its condition easily. -About what you paid for it, since adverse selection in the used car market means that almost-new cars are expected to be good quality. -Significantly less than what you paid for it. Selling a brand-new car is unusual and adverse selection suggests there is something wrong with it, so buyers will expect a major discount. -Significantly less than what you paid for it. Moral hazard suggests to buyers that you treated the car very badly for the two months you owned it.

Significantly less than what you paid for it. Selling a brand-new car is unusual and adverse selection suggests there is something wrong with it, so buyers will expect a major discount.

You are driving on a trip and have two choices on the highway to stop for a snack: a well-known chain or a local restaurant that you have never heard of but that looks okay. What lessons from this chapter might lead you to choose the chain even if you think that their food is just average? -The chain has a stronger incentive to maintain its reputation than the local place—you are likely to encounter another instance of the chain elsewhere, but the local restaurant will get you to buy at most one meal there. -Eating at the local restaurant presents an adverse selection problem. The owners of the local restaurant could have bought a franchise instead of operating independently, but their management skills are clearly insufficient for the chain's standards. -Eating at the local restaurant presents a moral hazard problem. Once you are seated, the local restaurant can treat you poorly and it is likely you will not leave. -That the local restaurant is still local and not a chain is a signal that the local restaurant is worse than the chain. If the local restaurant were a better establishment, it is reasonable to expect it to grow to more than one location. How might you choose differently if you had access to the Internet? -Having access to the Internet enables you to gather more information by reading reviews, but since most reviews would be from local diners, the signals would be less useful to you as an outsider. -Potential diners having Internet access gives the local restaurant a stronger incentive to maintain a good reputation. You may be able to only dine there once, but you are still able to leave a bad review if the restaurant does not meet expectations. -Internet access would not change the information relevant to the decision of where to eat. The logic in the previous part stands.

The chain has a stronger incentive to maintain its reputation than the local place—you are likely to encounter another instance of the chain elsewhere, but the local restaurant will get you to buy at most one meal there; Potential diners having Internet access gives the local restaurant a stronger incentive to maintain a good reputation. You may be able to only dine there once, but you are still able to leave a bad review if the restaurant does not meet expectations.;

You are a government policymaker with the responsibility to propose a policy that will reduce adverse selection in the health insurance market. Which of the following policies would achieve that goal? -The government will fund a public information campaign to reduce risk aversion. -The government will protect the people's right to keep their personal information private. -The government will ensure that people can opt-in and opt-out of health insurance at any time. -The government will subsidize the cost of health insurance.

The government will subsidize the cost of health insurance.

How might you choose differently if these two choices were in your neighborhood? -As a local yourself, you know that the best restaurants are always located on the highways. -The local restaurant now has an equally strong motive to maintain a good reputation with you. Like the chain, the local restaurant can earn repeat business from you. -Eating at the local restaurant still presents a moral hazard problem. Once you are seated, the restaurant can treat you poorly with a lower risk of your leaving.

The local restaurant now has an equally strong motive to maintain a good reputation with you. Like the chain, the local restaurant can earn repeat business from you.

Which is an example of a credible promise? -In a new, high-quality television ad, Mattress Connect promises to have the best deals in town. -A video game publisher's marketing team promises fans that its next video game will have the best story and graphics ever created. -A building contractor wins a bid for building a new subdivision by promising homes of exactly the same quality as those of other contractors, but at a much lower cost. -Tony's Used Cars promises that all its cars are high quality and offers a two-year, 10,000 mile warranty with every purchase.

Tony's Used Cars promises that all its cars are high quality and offers a two-year, 10,000 mile warranty with every purchase.

Which of the statements are examples of signaling? Choose all that apply. There is more than one correct answer. -Tommy's Tea Shop advertises by recording the testimonials of satisfied customers. -Jo decides to go to graduate school so her future employer will know that she is smart and a hard worker. -A name-brand bleach is priced 45% higher per gallon than the generic alternative. -Fred's Used Cars offers a warranty on every car sold. -Haley uses her 4.0 grade point average to land a new job.

all of the above

A dental insurance company charges premiums higher than average dental costs across a population and loses money. When it keeps raising the premiums on its policies, its losses keep rising. The dental insurance company is facing -an adverse selection death spiral. -sellers with diminishing market power. -the challenge of high growth of demand. -the challenge of having private information not known by the buyers.

an adverse selection death spiral.

Carfax is a web‑based service that supplies vehicle history reports to individuals on used cars: ownership history, vehicle mileage, accident reports, and other information. The existence of Carfax as a third‑party verifier in the used car industry can result in which of the following? Carfax could lead to (multiple answers) -an increase in the number of cars available in the used car market. -a reduction in the variance in the quality of cars in the used car market. -an efficient outcome in the used car market.

an increase in the number of cars available in the used car market.; an efficient outcome in the used car market.

Match each scenario to the appropriate insurance term. You are currently in a labeling module. 1. Kevin pays $5 for his prescription and his insurance company pays the remainder of the cost. 2. Each year, the Clarke family pays the first $500 of their medical expenses before their insurance company starts paying. 3. Each time Carlos visits the doctor, he pays $20 and his insurance company pays the remainder of the cost. 4. After his deductible has been paid, Corin pays 20% of the cost of his doctor visits. 5. Sarah is required to pay the full amount of her doctor visits until she has spent $1,200 on health care. After that, her insurance company will pay 100% of the cost of her doctor visits. -co‑payment -deductible -coinsurance payment -deductible

co-payment; deductible; co-payment; coinsurance payment; deductible

Golden Care provides lawn services in residential areas. They advertise by paying workers to put flyers on front doorknobs where residents are most likely to see them. Initially, these workers were paid based on how many flyers they distribute. After a few days of noticing flyers attached to mailboxes, side mirrors of cars, and dropped in gutters, Golden Care decides to change the incentives to improve the quality of the work performed. Which form of compensation is the best way to improve worker incentives? -compensation based on the number of new customers who respond to flyers -compensation based on how quickly workers distribute the flyers -compensation in the form of an hourly wage -compensation based on how long they have worked at the company

compensation based on the number of new customers who respond to flyers

Pak is one of many sellers of green beans in local farmer's markets where consumers are willing to pay more for organically grown green beans than regular green beans. However, the buyers have no way to verify whether any of the green beans for sale are grown organically. As a result of this -the market price tends to be high because all sellers claim to sell organic green beans. -green beans end up selling at low prices because buyers are skeptical. -green beans are not sold because there is no trust in the market. -most of the green beans sold will be organic because sellers want to cater to customers.

green beans end up selling at low prices because buyers are skeptical.

Suppose there are only two types of people, healthy people who never get sick and unhealthy people who have very high health care costs. Suppose that each person can work for one of only two firms. The firm of Globo‑Gym pays all health insurance costs and their insurance covers all possible health issues. The company Dharma Initiative pays a small part of the health insurance costs and requires high copayments, but they also pay higher wages to compensate healthy people for their health costs but not unhealthy people. Also, assume that the two firms produce the exact same product and the types of work employees perform at the firms are identical. Which type of workers will likely work for Dharma Initiative? -unhealthy workers only -healthy workers only -both types

healthy workers only

Advances in technology make it less expensive for people to take a DNA test that provides them—but not their health insurer—with information about their risk of developing various diseases. This will (increase/ decrease) the problems associated with adverse selection by (providing individuals with increased private information about their health conditions/ enabling individuals to make better decisions about their mental care)

increase; providing individuals with increased private information about their healthcare

A seller's verbal assurance that a used car is high quality: -is not effective at reducing the problems associated with asymmetric information. -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. -is an effective way for sellers to prove that the good they are selling is of high quality. -provides the same protection against adverse selection than does a repair guarantee.

is not effective at reducing the problems associated with asymmetric information.

Fill in the blanks to outline the logic of the adverse selection problem in the health insurance market. Insurance companies, (lacking/having) complete information about the health status of individuals, (cannot know/ know with certainty) whether an individual is a high‑cost or a low‑cost customer. If they charge premiums based on the expected average cost per customer, some (low‑cost/high cost) individuals will choose not to purchase insurance. This would increase the average cost of providing insurance and force insurance companies to raise premiums. Higher premiums, however, cause still more (low‑cost/high cost) customers to stop purchasing insurance, so that insurance premiums rise still more. Ultimately, this process may cause the insurance market to collapse.

lacking; cannot know; low cost; low cost

In this scenario, potential buyers base their offers on their perceptions of the proportion of homes on the market that have been properly maintained. Potential buyers may see a large proportion of homes that require maintenance. In this case buyers will likely offer (lower prices for high-quality homes/ higher prices for low cost homes) than they would if they were certain that homes have been properly maintained. At the same time, sellers of well‑maintained homes may (price their homes too low/ not offer their homes for sale) This situation is known as (adverse selection of sellers/ moral hazard/ adverse selection of buyers)

lower prices for high-quality homes; not offer their homes for sale; adverse selection of sellers

Bill is currently claiming unemployment. He reads that unemployment benefits are going to be extended and decides that he does not need to put as much effort into looking for a job. Which type of information asymmetry does the scenario best represent? -moral hazard -adverse selection -moral failure -screening

moral hazard

For each scenario, indicate whether it is an example of adverse selection of sellers, adverse selection of buyers, or moral hazard. your hire your neighbor to check on your cat every day while you are traveling for the week. The neighbor checks on your cat every other day instead.

moral hazard

Robert got a new job and relocated to a different city. He initially decided to stay in a small apartment close to his office.​ However, he decided to stay in a much bigger and costlier apartment when he found out that his employer would pay him a house rent allowance. This is an example of​ ________. -none of these -moral hazard -adverse selection -the free-rider problem

moral hazard

Some health insurance providers pay a single, set amount for the diagnosis and treatment of a specific illness. This payment scheme is meant to reduce: -poor incentives. -the likelihood that doctors will prescribe too few tests to diagnose the patient. -asymmetric information. -moral hazard.

moral hazard.

When you are considering renting an apartment or house, almost all landlords will require that you pay a refundable security deposit. The need for landlords to charge a security deposits reflects (moral hazard/ adverse selection of buyers/ adverse selection of buyers) In particular, since tenants do not own the property in which they live, (they may not feel obligated to maintain the property as well as someone who incurs the full cost of ownership/ on average they will be irresponsible types who are likely to damage the property)

moral hazard; they may not feel obligated to maintain the property as well as someone who incurs the full cost of ownership

Consider a used car market in which half the cars are good and half are bad (lemons). A rational buyer in this market should -save up and buy a new car. -offer to pay a price equal to the most she would pay for a good car. -offer to pay a price somewhere between the price she would pay for a good car and the price she would pay for a lemon. -offer to pay a price equal to the most she would pay for a lemon.

offer to pay a price somewhere between the price she would pay for a good car and the price she would pay for a lemon.

Veronica manages a team of medical transcribers, who all work from home and are paid hourly. hat are some potential problems she may encounter in getting the most productivity possible out of her employees? (multiple answers) Workers -paid hourly have an incentive to do no more than the minimum work necessary. -know their own capabilities better than she does, so only the most unsuitable workers will seek jobs with her company. -who are remotely located cannot be fully monitored to ensure they do not shirk their duties.

paid hourly have an incentive to do no more than the minimum work necessary; who are remotely located cannot be fully monitored to ensure they do not shirk their duties.

Hidden actions are a type of _____ that creates moral hazard. -risk aversion -private information -complement -monitoring

private information

Taren earns a certificate in a software program that is used by professionals in the field in which Taren wants to start a career. Obtaining the certificate: -signals that Taren is a good candidate for the job. -indicates that Taren is less qualified than other candidates. -eliminates the principal-agent problem between Taren and her employer. -increases the moral hazard of hiring Taren.

signals that Taren is a good candidate for the job.

Which is NOT an example of moral hazard? -A physician recommends an unnecessary diagnostic test. -A car repair shop recommends new tires to replace old ones that are still good. -A restaurant serves an undercooked meal. -A car salesman recommends an overpriced warranty.

A restaurant serves an undercooked meal.

Which is an example of moral hazard? -A driver drives faster than the speed limit. -A car salesman recommends a car that has been wrecked and repaired. -A car dealership offers a warranty. -A hairdresser colors a client's hair poorly.

A car salesman recommends a car that has been wrecked and repaired.

Private insurance companies also have an interest in finding ways to reduce the problems resulting from adverse selection. Insurance companies could -offer different types of plans, e.g., one with a high deductible and a low premium and one with a low deductible and a high premium. -avoid covering people with preexisting conditions. -require applicants to undergo physical examinations with a physician of the applicant's choice.

offer different types of plans, e.g., one with a high deductible and a low premium and one with a low deductible and a high premium; avoid covering people with preexisting conditions.

A signal is: -an action taken to credibly convey information that is hard for someone else to verify. -a price tag. -an indicator of the equilibrium wage and quantity in a market. -advance notice of an action that will be taken in the future.

an action taken to credibly convey information that is hard for someone else to verify.

The government mandates that all drivers purchase auto insurance. This will (increase/ decrease) the problems associated with adverse selection of buyers by (increasing the demand for insurance, making automobile insurance more unaffordable/ ensuring that insurance companies aren't stuck with only expensive, high-risk drivers)

decrease; ensuring that insurance companies aren't stuck with only expensive, high-risk drivers

If the price of health insurance is set so that health insurance companies can cover the expected costs of selling the policies: -healthy people may find the cost of the policies too high and not purchase them. -doctors will prescribe more health services than their insured patients need. -unhealthy people will find health insurance policies worth more. -insurance companies will be able to lower the price of the policies.

healthy people may find the cost of the policies too high and not purchase them.

Suppose there are only two types of people, healthy people who never get sick and unhealthy people who have very high health care costs. Suppose that each person can work for one of only two firms. The firm of Globo‑Gym pays all health insurance costs and their insurance covers all possible health issues. The company Dharma Initiative pays a small part of the health insurance costs and requires high copayments, but they also pay higher wages to compensate healthy people for their health costs but not unhealthy people. Also, assume that the two firms produce the exact same product and the types of work employees perform at the firms are identical. Which type of workers will likely work for Globo‑Gym? -unhealthy workers only -both types -healthy workers only

unhealthy workers only

Because warranties are potentially ________, low-quality goods are ________ to have warranties. -very expensive; less likely -very expensive; more likely -inexpensive; less likely -inexpensive; more likely

very expensive; less likely

Suppose the government wants to mitigate the market failure problem that results from adverse selection in the health‑care market. The government could -mandate that all individuals purchase health insurance. -require insurance companies to cover all applicants. -itself act as the primary insurer.

mandate that all individuals purchase health insurance.; itself act as the primary insurer.

Adverse selection is a potential source of market failure. (T/F)

true

Adverse selection occurs because of asymmetric information. (T/F)

true

Adverse selection problems can be addressed when the uninformed side of the market acquires more information. (T/F)

true

A fruit retailer buys 50 pounds of apples from the wholesale market every day. The retailer has observed that​ 20% of the apples bought each time are not of good quality. Since it is not possible for the retailer to check each apple before​ buying, how much should he pay for each pound if he values good apples at​ $1.40 per pound and has a value of zero for​ bad-quality apples? $1.20 $0.80 $0.70 $1.12

$1.12

Suppose a large firm allows its employees to choose whether to participate in its health insurance plan. The firm is trying to decide between two​ plans: Plan I has a low monthly premium but a high​ deductible, and Plan II has a high monthly premium but a low deductible. Under which plan is adverse selection likely to be a bigger​ problem? -Plan II because it is likely to draw employees who tend to overconsume health care services because of the low deductible. Insurance companies are likely to end up paying out more claims than the premiums they collect. -Plan I because it is likely to draw the relatively healthy employees who do not expect to spend much on health care. Because the monthly premiums are​ low, the insurance company has to bear a bigger financial burden in the event of serious illnesses. -Plan I because it is likely to draw participants who expect high medical costs. This group expect to consume much health care services and therefore prefer low deductibles. -Plan II because it is likely to draw participants who expect high medical costs. Healthy individuals who do not expect to consume much health care services will not be willing to pay the high premiums.

Plan II because it is likely to draw participants who expect high medical costs. Healthy individuals who do not expect to consume much health care services will not be willing to pay the high premiums.

Suppose that you are in charge of an insurance company. Two kinds of people want insurance, healthy people who probably will not get sick this year and unhealthy people who probably will get sick this year. Healthy people expect to pay, on average, $2,000 on medical bills this year. Unhealthy people expect to pay, on average, $6,000 on medical bills this year. Consider these assumptions and then answer the problem. (i) People will not pay more for insurance than they expect to pay in medical bills; people are risk neutral. As such, healthy people will not pay more than $2,000 for insurance, and sick people will not pay more than $6,000. (ii) You want to insure as many people as possible, but you cannot charge less for insurance than you expect to pay out. If you do, you will go bankrupt, and you will not be able to pay the medical bills of some people who get sick. (iii) People know whether they are healthy or unhealthy, but it is either impossible or illegal for you to know whether a person is healthy or unhealthy. This means that you cannot charge less to healthy people and more to sick people since you do not know which individuals fall into each group. (iv) There are an equal number of healthy and unhealthy people. How much will you charge for insurance in equilibrium, and who will buy insurance? -You charge $2,000, and everyone buys insurance. -You charge $6,000, and only unhealthy people buy insurance. -You charge $6,000, and everyone buys insurance. -You charge $2,000, and only healthy people buy insurance.

You charge $6,000, and only unhealthy people buy insurance.

A principal-agent problem can arise when -an agent hires a principal to do something on their behalf, and the agent can observe the principal's actions. -a principal uses an agent to accomplish a task the principal wants credit for completing. -an insurance agent sells a policy to a buyer who uses it as an incentive to behave badly. -a principal hires an agent to do something on their behalf, but the principal cannot perfectly observe the agent's actions.

a principal hires an agent to do something on their behalf, but the principal cannot perfectly observe the agent's actions.

A terminally ill person opts to purchase life insurance without disclosing his or her illness. What type of asymmetric information is this? -moral hazard -adverse selection -signaling -screening

adverse selection

For each scenario, indicate whether it is an example of adverse selection of sellers, adverse selection of buyers, or moral hazard. People with asthma are more likely to buy health insurance

adverse selection of buyers

For each scenario, indicate whether it is an example of adverse selection of sellers, adverse selection of buyers, or moral hazard. Your local seafood shop advertises fresh seafood, but you are not certain if the seafood is actually fresh or if it has been frozen

adverse selection of sellers

Reginald, who is chronically ill, opts to purchase health insurance without disclosing his illness. Buffy, who is in perfect health, decides to forego purchasing health insurance altogether. This is an example of -signaling. -moral hazard. -adverse selection. -screening.

adverse selection.

Rihanna would like a better car, and she considers selling her old one by advertising on Kijiji. She decides against it because the used cars listed on Kijiji are underpriced. This example illustrates the problem of: -adverse selection. -moral hazard. -positive correlation. -risk aversion.

adverse selection.

Suppose there are only two types of people, healthy people who never get sick and unhealthy people who have very high health care costs. Suppose that each person can work for one of only two firms. The firm of Globo‑Gym pays all health insurance costs and their insurance covers all possible health issues. The company Dharma Initiative pays a small part of the health insurance costs and requires high copayments, but they also pay higher wages to compensate healthy people for their health costs but not unhealthy people. Also, assume that the two firms produce the exact same product and the types of work employees perform at the firms are identical. We see the sorting this way because of -adverse selection. -moral hazard.

adverse selection.

Sophia operates her own accounting practice and is looking to hire two entry‑level accountants. A high‑productivity worker will generate $90,000 in revenue per year and a low‑productivity worker will generate $60,000. Tasia is a high‑productivity worker and wants a salary of at least $80,000. Rick is a low‑productivity worker and wants at least a $55,000 salary. If Sophia can easily identify the type of worker, she should hire (neither of them/ both of them/ only tasia/ only rick) Sophia's total profit will be _____

both of them; $15,000

Google decides to offer multiple health care plans to its employees. One plan offers a high deductible, but a low monthly premium. The other plan offers a low deductible but a high monthly premium. This will (increase/ decrease) the problems associated with adverse selection of buyers by (allowing employees to be more secretive about their health conditions/ compelling employees to reveal whether they are high-risk or low-risk cases)

decrease; compelling employees to reveal whether they are high-risk or low-risk cases

Buyers are the only group that suffers from information asymmetries. (T/F)

false

Insurance markets are rarely subject to adverse selection. (T/F)

false

Sellers are the only ones who suffer from information asymmetries (T/F)

false

Veronica manages a team of medical transcribers, who all work from home and are paid hourly. What are some possible solutions? (multiple answers) Veronica could -mandate that individuals work a set number of hours to ensure that a sufficient amount of work is completed. -introduce a profit‑sharing arrangement, with commissions based on the amount of work completed. -have individuals work in teams and reward teams for their performance.

introduce a profit‑sharing arrangement, with commissions based on the amount of work completed.; have individuals work in teams and reward teams for their performance.

When a health insurance company sells an insurance policy, adverse selection suggests that: -only unhealthy people will purchase a policy. -doctors will prescribe more health services than their insured patients need. -people will purchase the insurance and then use more health care than they need. -people who purchase the policies will demand more expensive procedures.

only unhealthy people will purchase a policy.

Offering a warranty is an example of: -adverse selection. -signaling. -the principal-agent problem. -moral hazard.

signaling.

If education merely signals an ability to learn, there is reduced pressure on colleges and universities to: -ensure that students receive financial assistance. -reduce the workload. -teach something useful. -ensure that students graduate.

teach something useful.

An inefficiency in obtaining education to signal IQ or work ethic is: -that education is relatively inexpensive. -that there may be a cheaper way to signal these. -that too much work is needed. -reduced time to work.

that there may be a cheaper way to signal these.

When a principal-agent problem occurs, the agent engages in actions that -the principal can't observe, and they are not in the principal's best interest. -are based on risk aversion rather than the principal's best interest. -are impulsive rather than planned and that end up working against the agent's best interest. -result in lemons that harm the agent rather than the principal.

the principal can't observe, and they are not in the principal's best interest.

According to the principal-agent problem, when the principal hires the agent to complete a task but is unable to watch the agent complete it, the agent has an incentive to -do the opposite of what is asked. -do exactly what is requested. -underdeliver. -overdeliver.

underdeliver.

Which is the best definition for the term moral hazard? -when one side of an economic transaction has more information about the good being exchanged than the other side has -when businesses pursue profit at the expense of employee well-being -when people take unwise risks -when people who are not responsible for the entire costs of their actions take riskier actions than they would otherwise take -when imperfect information implies that people must choose from an undesirable selection of goods -when consumers must decide whether to purchase goods from firms with potentially objectionable business practices -when people engage in hazardous activities because of a deficient moral code

when people who are not responsible for the entire costs of their actions take riskier actions than they would otherwise take