ECON 202 Chapter 10

Signals are believable when the cost of sending a ________ is known to be ______.

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Which of the following is a problem that arises in a health insurance market? A. A disproportionate number of high-risk individuals are attracted to buy insurance. B. There exists a fierce competition between the insurance providers. C. Only risk-averse individuals buy insurance. D. There are a large number of buyers of various insurance programs.

A. A disproportionate number of high-risk individuals are attracted to buy insurance.

Which of the following is an example of a way in which health insurance companies have dealt with the problem of adverse​ selection? A. limiting insurance coverage on​ pre-existing conditions B. reducing reimbursements to doctors and hospitals C. eliminating deductibles D. eliminating coinsurance

A. limiting insurance coverage on​ pre-existing conditions

Asymmetric information is a situation in which one party to an economic transaction has less information than the other party. Two types of problems associated with asymmetric information are adverse selection and moral hazard. Which of the following is an example of moral hazard​? An example of moral hazard is A. sick people being more likely to purchase health insurance than healthy peoples. B. those without​ pre-existing health problems being more likely to purchase health insurance than those with​ pre-existing health problems. C. those without health insurance using illegal drugs. D. doctors prescribing unnecessary tests for those with health insurance E. old people being more likely to purchase health insurance than young people

A. sick people being more likely to purchase health insurance than healthy people.

​Scenario: You walk onto a​ used-car lot to buy your first car.​ However, you are not sure about the quality of the cars in the lot and expect​ one-third of them to be of poor quality. Refer to the scenario above. Suppose you decide to buy a Toyota Corolla. You value the car for​ $10,000. You​ don't know​ it, but the car dealer values it for​ $8,500. If you have a zero value for​ poor-quality cars, what is the most that would you be willing to pay for the​ car? A. $6,666.67 B. $5,000 C. $3,000.50 D. $10,000

A. ​$6,666.67

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? A. $1.40 per pound B. $1.12 per pound C. $1.20 per pound D. ​$2 per pound

B. $1.12 per pound

A factory urgently needs to hire some workers. The factory owner is willing to pay a wage of​ $15 per hour to responsible workers and is unwilling to hire workers who require constant monitoring. On​ average, he expects 5 out of 10 workers who have come for an interview to be sincere. How much should he offer to pay the workers he​ hires? A. $8 per hour B. $7.50 per hour C. $10 per hour D. $15 per hour

B. $7.50 per hour

Briefly explain whether you agree with the following​ statement: ​"The reluctance of healthy young adults to buy medical insurance creates a moral hazard problem for insurance​ companies." A. Disagree.​ Young, healthy adults do not need insurance.​ Thus, selling insurance to someone who​ doesn't need it would be a moral hazard. B. Disagree. Moral hazard becomes a problem after one purchases insurance. In this​ case, the reluctance of​ young, healthy adults to purchase insurance in the first place leads to an adverse selection problem. C. Agree. The only way for insurance companies to get​ young, healthy adults to buy insurance is to lower the price. ​ However, this is a form of price​ discrimination, which is often referred to as a moral hazard problem. D. Agree. We have a moral obligation to be covered by insurance so that in the event we do become sick or injured taxpayers​ won't be stuck paying our bills.

B. Disagree. Moral hazard becomes a problem after one purchases insurance. In this​ case, the reluctance of​ young, healthy adults to purchase insurance in the first place leads to an adverse selection problem.

What is adverse selection? A. It refers to the private, self-interested actions people that people pursue, which when taken collectively leads to a loss in economic surplus. B. It refers to the situation in which one party to a transaction takes advantage of knowing more than the other party to the transaction. C. It refers to the actions people take before they enter into a transaction so as to mislead the other party to the transaction. D. It refers to the actions people take after they have entered into a transaction that make the other party to the transaction worse off.

B. It refers to the situation in which one party to a transaction takes advantage of knowing more than the other party to the transaction.

Suppose that in a market for used​ cars, there are good used cars and bad used cars​ (lemons). Consumers are willing to pay as much as​ $6,000 for a good used car but only​ $1,000 for a lemon. Sellers of good used cars value their cars at​ $5,000 each and sellers of lemons value their cars at​ $800 each. Buyers cannot tell if a used car is reliable or is a lemon. Based on this​ information, what is the likely outcome in the market for used​ cars? A. Sellers of good used cars will incur losses. B. Sellers of good used cars will drop out of the market. C. Sellers of lemons will drop out of the market. D. Used cars will sell for​ $3,000.

B. Sellers of good used cars will drop out of the market.

One result of asymmetric information about people's ability to repay a loan is that: A. banks will not make loans. B. a bank could make many loans to people who don't pay them back. C. loans will only be made to people who don't pay them back. D. lenders are better off than with perfect information.

B. a bank could make many loans to people who don't pay them back.

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? A. 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. B. 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. C. 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. D. 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.

C. 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.

An insurance company is likely to attract customers like Clancy who want to purchase insurance because he knows better than the company that he is more likely to make a claim on a policy. What is the term used to describe the situation above? A. asymmetric information B. moral hazard C. adverse selection D. economic irrationality

C. adverse selection

In order to be useful as a signal in a market with information asymmetry, the signal must be ________. A. inexpensive B. easily available C. difficult to obtain D. unique

C. difficult to obtain

What is likely to happen in a used-car market if the buyers feel that the best they can do is to buy a lemon? A. Higher gains from trade are realized. B. The sellers of gems reap high profits. C. The sellers of lemons earn high profits. D. The entire market shuts down.

D. The entire market shuts down.

One consequence of imperfect information in the health insurance market is that: A. unhealthy individuals are denied health insurance. B. the most healthy individuals are more likely to buy insurance, leaving the least healthy without access to health care. C. health insurance increases the demand for health care and so increases the price of health care. D. less healthy individuals are more likely to buy insurance, driving up the cost of insurance for everyone.

D. less healthy individuals are more likely to buy insurance, driving up the cost of insurance for everyone.

Adverse selection

Is the situation in which one party to a transaction takes advantage of knowing more than the other party to the transaction.

Asymmetric information

Occurs when one party to an economic transaction has less information than the other party.