Micro Chapter 16

Asymmetric information creates problems in markets that lead to market failure. Two main problems are adverse selection and moral hazard. Read each scenario below and determine which of these problems is present, then assign the appropriate label. Kathy is a 32 year old fast food employee with a high school degree. She has major credit card debt. She hears about a program that promotes homeownership by offering $5,000 in down payment assistance to a limited number of individuals who have an income of $40,000 or less. She applies for and receives the assistance. When Jill, who has outstanding credit, applies no more loans are available.

Adverse Selection

A firm can signal consumers that their product if high quality in a number of ways. Sort the signaling devices listed below by whether the cost of the signal is incurred before or after goods are sold. Before any sales are made:

Advertising, Reputation

A free market underallocates scarce resources to the production of a good when there is: a positive externality. imperfect information. market power. All of the above.

All of the above.

Why might the state of California require furniture upholsterers to obtain occupational licenses?

As a way to provide reassurance about the quality of the furniture upholsterer\'s work.

Which of the following would NOT give an individual incentive to abstain from moral hazard?

Billy finds out he has a 10 year warranty on his Lifetime folding table that he bought 2 weeks ago. In the past, Billy has put his equipment under heavy abuse.

The housing market often involves transactions with asymmetric information. Which of the following accurately characterizes the information asymmetry?

The person selling a house has better knowledge about the condition of the house and how likely repairs are needed than the person buying the house.

Asymmetric information creates problems in markets that lead to market failure. Two main problems are adverse selection and moral hazard. Read each scenario below and determine which of these problems is present, then assign the appropriate label. Bill is currently claiming unemployment. He reads that unemployment benefits are going to be extended and decides he doesn\'t need to put as much effort into looking for a job.

Moral Hazard

Which of the following is a step often taken to minimize the information asymmetry in these types of transactions?

Sellers will offer a home warranty.

Assuming the insurance company either never discovers the deception or that it cannot change the policy after discovering the deception. What is the result?

The cost of the chronically ill person is absorbed by other policy holders.

A firm can signal consumers that their product if high quality in a number of ways. Sort the signaling devices listed below by whether the cost of the signal is incurred before or after goods are sold. Only After sales are made:

Warranty, Money back guarantee

Select the option that provides the best definition for the term \"moral hazard.\"

When people that aren\'t responsible for the entire costs of their actions take riskier actions than they would otherwise.

A situation in which one party to a contract alters his or her behavior in ways that can be costly to the other party after entering into a contract is:

a moral hazard problem.

A chronically ill person opts to purchase health insurance without disclosing his or her illness. This is an example of _______.

adverse selection

Moral hazard occurs _____ a transaction has been completed; adverse selection occurs _____ a transaction has been completed.

after; before

The three year extended guarantee is an example of a(n):

service contract

An economic signal is...

some information that helps people to make better decisions economically.

Apple Macbooks have become increasingly popular among college students. When you purchase a Macbook, it comes with a 1 year guarantee that any and all issues will be fixed by Apple free of charge. After that one year though you are on your own. In addition, you can buy AppleCare, where at an additional cost, the 1 year guarantee is extended to 3 years. The one year guarantee is an example of a(n):

warranty