ECON Exam 4

What are solutions to a moral hazard problem?

-pick the right kind of agents -give the actor "skin in the game," or a stake in the outcome -reward things that go along with the actions you want

A(n) _____ gives an inventor a temporary monopoly on the use or sale of an invention.

patent

On a graph of a company's cost, revenue, and demand curves, the company's profit margin can be identified as the gap between _____ and _____ for a given quantity.

price; average cost

The Thompsons use video surveillance to ensure that the lawn care company they employ applies the lawn fertilizer and weed controller they paid for. This is an example of solving a(n):

principal-agent problem through monitoring

(Scenario: Jillian's Cupcake Shop) Use Scenario: Jillian's Cupcake Shop. Scenario: Jillian's Cupcake Shop Jillian runs a cupcake shop where she sells cupcakes for $1 each. She employs five people, each of whom worked a total of 500 hours last year; she paid them $10 per hour. Her costs of equipment and raw materials add up to $75,000. Her business ability is legendary, and other companies have offered to pay Jillian $100,000 to come to work for them. She also knows she could sell her cupcake shop for $150,000. The bank in town pays an annual interest rate of 3% on all funds deposited with it. Jillian's implicit opportunity and explicit financial costs are:

$204,500

the cost used to calculate economic profit are:

accounting costs and implicit opportunity costs

Total revenue minus expenses paid equals:

accounting profit

Without the U.S. Department of Agriculture's Certified Organic seal, most conventional and organic blueberries would look identical to the average consumer. This is an example of the government:

providing information directly to buyers

(Scenario: Accounting and Economic Profit) Use Scenario: Accounting and Economic Profit. Scenario: Accounting and Economic Profit Casey recently inherited $100,000 from her grandmother. Rather than invest the money in a mutual fund that earns 5% per year, she quit her job as a translator for the United Nations, which paid $60,000 per year, and started Casey's Coffee Crush, a small café in Tribeca. The location she rented cost $20,000 for the year. The equipment, café furniture, and coffee machines cost another $60,000. Staff, sales help, and advertising cost yet another $40,000. In her first year, her revenue was $150,000. The economic profit of Casey's Coffee Crush is:

$120,000

Until recently, Davina worked as an insurance claims adjuster, earning $30,000 annually. Then she inherited a piece of commercial real estate that had rented for $12,000 annually. Davina decided to leave her job and operate an Italian restaurant in the space she inherited. At the end of the first year, her books showed total revenues of $260,000 and total costs of $230,000 for food, utilities, cooks, and other supplies. Her economic profit at the end of one year is:

-$12,000

Your company is an aspiring PC maker that wants to break into a market dominated by a few PC giants—Dell, Lenovo, HP, Acer, and Asus. In particular, these companies have large cost advantages over your company, giving them both scale economies and large R&D budgets. Which strategy might help your company overcome these barriers?

Partner with another major maker of PCs to access the R&D of an experienced firm and place an initial product on the market, which could, in turn, gain the confidence of investors.

In York, England, local residents pay lower parking fees than tourists. While the official rationale for this practice is that residents use city facilities throughout the year and contribute more to city taxes than tourists do, what economic rationale might there be for it?

Tourists have more inelastic demand than local residents

When setting prices for different groups of customers, a manager should charge higher prices to groups that have _____ and lower prices to groups that have _____.

a higher marginal benefit; lower reservation prices

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

a young adult in good health

If Giordano's Pizza in Chicago computed its profits without taking into account its implicit opportunity costs, it would then only be considering its _____ profit.

accounting

Suppose that Adidas and Kanye West collaborate to produce a high-end sneaker called Yeezys. At first, some people sell authentic Yeezys on eBay, but the high price attracts more sellers into the market, some of whom secretly sell fake Yeezys. Since buyers can't tell the difference between real and fake Yeezys from the information in the listing, they're not willing to pay as much for a pair as they would be if they knew that the sneakers were authentic. As the price falls below what authentic sellers are willing to accept, the latter stop selling on eBay until only fake Yeezys remain. This self-propagating cycle is a(n):

adverse selection death spiral

When buyers cannot tell whether a product is high- or low-quality before making a purchase:

both high-quality and low-quality units of the product will sell at the same price.

The shampoo aisle at a large store that sells personal care products contains many versions of shampoo produced by a small number of companies. This indicates that shampoo producers are engaging in _____ to _____.

brand proliferation; deter new entrants

If a company engages in perfect price discrimination, it is attempting to:

charge each customer their reservation price

When a company practices price discrimination, it will keep adding customers until the:

company's marginal cost equals the last customer's marginal benefit

Which is NOT something companies try to achieve through price discrimination? -charge each customer the highest price they are willing to pay -create barriers to entry -sell to every customer whose marginal benefit exceeds the firm's marginal cost -increase profits

create barriers to entry

Candice's stand-up paddleboard company will earn profits producing and selling at any output level where the company's:

demand curve is about its average cost curve

If firms are making economic losses, then in the long run:

firms will leave the industry

Which type of insurance is LEAST susceptible to moral hazard? -homeowner's insurance -car insurance -health insurance -life insurance

homeowner's insurance

Suppose a producer initially charges each customer the same profit-maximizing price, with marginal revenue equal to _____ cost. If the producer now engages in price discrimination, the producer's profit will _____.

marginal; rise

Which leads to a reduction in moral hazard by making hidden actions observable? -worker pay based on productivity -monitoring worker actions through video surveillance -additional hiring screenings to ensure that hard-working persons are hired -laws against theft and fraud to reduce those problems in workplaces

monitoring worker actions through video surveillance

When the government subsidizes the cost of health insurance:

more people will buy insurance, decreasing adverse selection

Individual pricing is a way to describe:

perfect price discrimination

When a principal-agent problem occurs, the agent engages in actions that:

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

Samantha wants to practice price discrimination in her cupcake bakery. Which strategy should Samantha NOT use? -volume discounts for customers who buy large numbers of cupcakes -discounted prices for customers who buy day-old cupcakes -an annual fee for customers who want to earn a 2% discount each time they shop in the bakery -the same price for all consumers for all cupcakes available

the same price for all consumers for all cupcakes available

When Allstate sells fire insurance policies, it often includes deductibles:

to minimize moral hazard

Why would your auto insurance policy state that if you cause an accident, your insurance premium will rise, and if you cause another accident, your coverage will be canceled?

to reduce moral hazard and incentivize safe driving

Average cost is:

total cost divided by quantity

why is market power necessary for price discrimination?

without market power, a seller would lose customers if the seller tried to charge a higher price

Which illustrates price discrimination through haggling? -Ajri sells five veggie burgers to five people at different prices, based on the time of day of the sale. -Max sells three TVs to three customers at two different prices, based on how many TVs he had already sold that day. -Pule sells three muffins to three customers at two different prices, depending on when he baked them. -Arturo sells five identical shovels to five people at different prices at his yard sale, based on negotiations with the buyers.

Arturo sells five identical shovels to five people at different prices at his yard sale, based on negotiations with the buyers.

Arlo owns a barbershop. What condition would make it difficult for him to price discriminate?

He lacks market power

How does a business owner know if it is financially worthwhile to open a business?

The business earns economic profits.

What causes adverse selection?

sellers with private information

Ulrik, an antiques dealer, acquires 12 authentic Tiffany lamps for $10,000 each— items that he knows from experience, he can sell for anywhere between $4,000 and $1 million each. He toys with the idea of pricing each at $30,000, which, given the projected demand shown in the accompanying diagram, would yield a revenue of $90,000 and a profit of $60,000 (and three unsold lamps, which he would save to sell at a later date).

$150,000; $100,000

Alana's Confectionary is located in the East Side Village. When the market price of iced brownies is $5, the profit-maximizing output level is 150 brownies. Alana's average cost is $4, and her variable cost per unit is $3. Alana's marginal cost is _____, and her short-run profits are _____.

$5; $150

what causes adverse selection?

-sellers having private information -buyers having private information -unobservable actions

A product that has more problems or inferior quality than the average unit available is known as a(n):

lemon

Ragnar owns a cheese shop in Carmel, California, and notices that most of his sales go to tourists rather than locals. How might Ragnar raise his profits?

Give a "local discount" to buyers who can establish local residency by presenting, for example, a driver's license.

How would you explain to a friend why an insurance company would go out of business?

Insurance insulates people from the consequences of their actions, which drives up claims and prices, leading to fewer customers paying premiums to cover the rising costs.

Mariko wants to buy a hand-knotted rug made without child labor. What challenge does she face in making this purchase?

It will be difficult for her to verify seller claims about the use of child labor.

In deciding how many segments to divide its market into, a company should look for ways to identify groups of consumers that have _____ demand.

distinctly different

Suppose that the market for cab rides is initially in long-run equilibrium. Subsequently, an increase in population increases the demand for cab rides. In the short run, the typical cab driver is likely to:

earn an economic profit

Wolfram Research once produced two versions of its software, Mathematica, a program used by businesses and researchers to perform advanced mathematical operations. One version was a high-priced professional product, which employed a computer's floating-point processor to speed up calculations. The other was a cheaper student version, which disabled the processor, slowing calculations significantly. To get the student version to function without the floating-point processor, Wolfram had to write more code, making the inexpensive version of Mathematica more costly to produce. Although Wolfram incurred additional costs to compromise the effectiveness of its student version, we can be sure that Wolfram was charging buyers of the student version a price _____ their reservation price and _____ Wolfram's marginal cost.

below; aboce

Economic profits encourage firms to _____ the industry, and losses encourage firms to _____ the industry.

enter; exit

When developing laws and regulations, elected government leaders are often biased in favor of the interests of established companies over those of new entrants because:

established companies and their employees are voters who have clear interests in preserving the success of established companies

Which strategy would allow a seller to develop unique cost advantages to create a barrier to new sellers entering its market? -gain market power as a buyer in a critical input market -convince the government to require licenses to enter the market -add switching costs to lock in customers -use brand proliferation to cover all market niches

gain market power as a buyer in a critical input market

what are the conditions needed for price discrimination?

-the company knows how much different customers are willing to pay for the product -the company has market power in its product -the company can keep customers from reselling the product after they have purchased it.

Which would NOT reduce the problem of information asymmetry? -Your friend reads Google Reviews of all restaurants of interest before choosing one for his upcoming first date. -A product contains a trademarked Certified Gluten-Free logo to protect consumers with Celiac Disease. -You buy a certified refurbished Vitamix blender from the company's website instead of a used Vitamix from a small seller on eBay. -The asking price for a used car from a private seller is equal to the average selling price for the car's make, model, and mileage.

The asking price for a used car from a private seller is equal to the average selling price for the car's make, model, and mileage.

Which statement about group pricing is FALSE? -The lower the reservation price of a group, the more price-sensitive the group is. -The lower the reservation price of a group, the less the group members value the product. -The lower the reservation price of a group, the more inelastic the group's demand for the product. -The lower the reservation price of a group, the lower the marginal benefit from the product.

The lower the reservation price of a group, the more inelastic the group's demand for the product

The Airbnb work offices contain destination-themed meeting rooms, fitness classes, wellness rooms, communal spaces, and multiple cafes, all housed in stunning architecture. Which does NOT describe the reasoning behind Airbnb's choices for the employee work environment?

The rewarding work environment is part of Airbnb's pay-for-performance program.

TrustedHousesitters.com links pet owners and pet sitters. Pet owners who wish to go on a trip but can't bring their pets with them can hire a pet sitter whose profile is available on the TrustedHousesitters website. In exchange for room and board and the opportunity to live in a different place for a time, the individual hired takes responsibility for a pet. Suppose there were an upstart competing service, say, PetSitters.com, that was trying to take market share from TrustedHousesitters.com. What problem might PetSitters.com encounter?

TrustedHousesitters.com is valuable because it already has a large base of subscribers, whereas PetSitters.com, lacking many subscribers, will be at a competitive disadvantage from the start.

Suppose the New York Rangers can rent out Madison Square Garden (the arena where they play hockey) to American Hockey League (AHL) affiliates for $11,000 per game. The $11,000 per game is the _____ cost of capital.

implicit opportunity

Caleb, who runs a dog-walking service, initially charges a uniform price to all his customers. When he identifies a group of potential customers in a lower-income neighborhood, he charges them a lower price (above his marginal cost but below their reservation price) while keeping the price he charges existing customers the same. As a result of Caleb's actions, consumer surplus _____, producer surplus _____, and total surplus _____.

increases; increases; increases

Suppose Savannah's art studio is charging the market price, which is slightly higher than her average cost. This means that Savannah:

is earning a small economic profit

if the accounting profit of a firm is negative:

its economic profit must be negative

As small book publishers have limited or no marketing budgets, they largely depend for sales on access to the world's largest online retailer, Amazon. Amazon, however, as part of its competitive strategy, pressures publishers to discount their books deeply, even to the point of driving some of them out of business. One head of a small academic publisher said, "I offered them a 30% discount. They demanded 40." When the publisher agreed to 40, Amazon returned, demanding 45. "Where do I find that 5%?" she said. "Amazon may be able to operate at a loss, but I'm not in a position to do that." In pressuring book publishers to discount their books, Amazon leverages:

its market power to get a better deal from suppliers

Car insurance companies often offer policies that combine high deductibles and low premiums. Policies with high deductibles are typically purchased by individuals who self-identify as:

low-risk drivers

Alexei chooses not to go to the movies, finding the price of $13 to see a movie exorbitant. When he learns that a double-feature costs $17, however, he goes, finding it a bargain. The movie theater is practicing what kind of price discrimination?

quantity discounts